Trading Around the Clock: Global

Securities Markets and Information

Technology

July 1990

OTA-BP-CIT-66
NTIS order #PB90-254087
Recommended Citation:
U.S. Congress, Office of Technology Assessment, Trading Around the Clock: Global
Securities Markets and Information Technology--Background Paper, OTA-BP-W-66
(Washington, DC: U.S. Government Printing Office, July 1990).

For sale by the Superintendent of Documents

U.S. Government Printing Office, Washington, DC 20402-9325
(order form can be found in the back of this report)
Foreword
The world’s stock exchanges evolved from centuries-old markets of money lenders,
currency traders, and commodity dealers. La Bourse, the Paris stock exchange, dates back to
1183. Amsterdam’s Effectenbeurs was formed around the trading of shares in the Dutch East
India Company in 1602. The London Stock Exchange was organized in the 17th century.
Stock exchanges in the United States, while latecomers, have a unique and colorful
history of their own, characteristic of our young nation. Wall Street, a narrow thoroughfare in
lower New York City, has become the symbol of U.S. enterprise, initiative, and prosperity. . .
but also of greed and chicanery. It was there that securities were first traded about 1725, along
with the auction of commodities such as tobacco, wheat, and even slaves. The New York Stock
Exchange, the first established in the United States, was chartered in 1792. Modern computer
and information technologies now support market-makers and brokers, and runners and ticker
tapes have given way to computer screens.
International telecommunications systems now link markets around the world with
instantaneous communications. Technology is rapidly turning the stock exchanges into a
seamless global market, open 24 hours a day. This situation presents both opportunities for
the Nation and problems that Congress needs to understand.
This background paper assesses the effects of information technology on securities
markets and the current status of global securities trading. It compares securities markets and
clearing and settlement mechanisms in Japan, the United Kingdom, and the rest of Europe with
those in the United States. Finally it identities emerging questions about international markets
and national regulatory regimes.
Trading Around the Clock precedes the forthcoming OTA report on domestic securities
markets and information technology, Electronic Bulls and Bears, both requested by the
Committee on Energy and Commerce and the Committee on Government Operations of the
House of Representatives.
OTA gratefully acknowledges the help of many people who have contributed to this
study as advisory panel members, workshop participants, contractors, and reviewers. As with
all OTA reports, however, the content is solely the responsibility of OTA and does not
necessarily constitute the consensus or endorsement of the advisory panel, workshop
participants, or the Technology Assessment Board.

u Director

iii
 Securities Markets and Information Technologies
Advisory Panel

Paul F. Glaser, Chairman

President, Quotron Systems, Inc.

John Bachman James Martin

Managing Partner Executive Vice President
Edward D. Jones& Co. Teachers Insurance Annuity Association
College Retirement Equities Fund
John C. Baldwin
Director Martin Mayer
Utah Department of Business Regulation Journalist

Allan Bretzer Robert McEwen

Vice President President
Midwest Stock Exchange Conference of Consumer Organizations

William Brodsky Charles McQuade

President and Chief Executive Officer President
Chicago Mercantile Exchange Securities Industry Automation Corp.

Eric Clemens Susan Phillips

Professor Vice President
Wharton School University of Iowa
University of Pennsylvania Peter Schwartz
James B. Cloonan President
President Global Business Network
American Association of Individual Investors Howard Sherman
Jack A. Conlon, Jr. Department of Economics
Executive Vice President University of California, Riverside
NIKKO Securities Co., Inc. Robert Shiller
Janine Craane Cowles Foundation
Financial Consultant Yale University
Merrill Lynch, Pierce, Fenner & Smith, Inc. Hans R. Stoll
Gene L. Finn Director
Chief Economist and Vice President Financial Markets Research Center
National Association of Securities Dealers Owen Graduate School of Management
Vanderbilt University
Richard Grasso
President and Chief Operating Officer Alan Strudler
New York Stock Exchange Research Scholar
Institute for Philosophy and Public Policy
William Haraf University of Maryland, College Park
Vice President
Citicorp
Robert E. Litan
Senior Fellow and Director of Center for Economic
Progress and Employment
Brookings Institution

NOTE: OTA appreciates and is grateful for the valuable assistance and thoughtful critiques provided by the advisory panel members.
The panel does not, however, necessarily approve, disapprove, or endorse this report. OTA assumes full responsibitity for the
report and the accuracy of its contents.
iv
Trading Around the Clock: Global Securities Markets and
Information Technology
OTA Project Staff

John Andelin, Assistant Director, OTA

Science, Information, and Natural Resources Division

James W. Curlin, Program Manager

Communication and Information Technologies Program

Project Staff
Vary T. Coates, Project Director

Charles K. Wilk, Senior Analyst

Danamichele Brennen, Inhouse Contractor

Steven Spear, Research Assistant

Mark Anstine, Research Assistant

Administrative Staff
Liz Emanuel, Office Administrator

Karolyn St. Clair, Secretary

JoAnne Price, Secretary

 Workshop Participants

Clearing & Settlement Junius Peake

The Peake/Ryerson Consulting Group, Inc.
Andrea Corcoran
Commodities Futures Trading Commission Joe Rhyne
Quotron Systems, Inc.
Dennis Dutterer
Chicago Board of Trade Clearing Corp. Donald D. Serpico
Chicago Mercantile Exchange
Dennis Earle
Bankers Trust Co. Casimir Skrzypczak
NYNEX Corp.
Roberta Green
Federal Reserve Bank of New York Donald Solodar
New York Stock Exchange
John Hiatt
Options Clearing Corp. Shyam Sunder
Carnegie-Mellon University
Jonathon Kalman
Securities and Exchange Commission Richard Van Slyke
Polytechnic University, New York
Gerard P. Lynch
Morgan Stanley Co., Inc. R.T. Williams
R. Shriver Associates, Inc.
John W. McPartland
Chicago Mercantile Exchange Scenarios on International
Junius Peake Securities Trading
The Peake/Ryerson Consulting Group, Inc. Peter Bennett
Michael Reddy International Stock Exchange
Merrill Lynch World Eric Clemens
Robert Woldow University of Pennsylvania
National Securities Clearing Corp. James Cochrane
New York Stock Exchange
Technology in Securities Markets
Richard Breunich Roberta Green
Merrill Lynch & Co., Inc. Federal Reserve Bank of New York

Ron Dale David Hale

Midwest Stock Exchange Kemper Financial Services

Patricia Hillman Martin Mayer

Bank of Boston Journalist

George Kenney Todd Petzel

American Stock Exchange Chicago Mercantile Exchange

Robert M. Mark Peter Schwartz

Manufacturers Hanover Trust Co. Global Business Network

Harold McIntyre Michael Wailer-Bridge

Citibank Financial Institutions Group International Stock Exchange

John Parady Manning Warren III

Pacific Stock Exchange University of Alabama School of Law

NOTE: OTA appreciates and is grateful for the valuable assistance and thoughtful critiques provided by the workshop participants.
The workshop participants do not, however, necessarily approve, disapprove, or endorse this report. OTA assumes full
responsibility for the report and the accuracy of its contents.

w’
 Reviewers and Contributors

Alden Adkins Gary Ginter Junius Peake

Securities and Exchange Commission Chicago Research & Trading Group, The Peake/Ryerson Consulting
Ltd. Group, Inc.
Anthony Ain
Securities and Exchange Commission Roberta Green Joseph Rosen
Federal Reserve Bank of New York Rosen, Kupperman Associates
David Aylwood
National Strategies, Inc. John Hiatt Thomas Russo
(for Reuters, International) Options Clearing Corp. Cadwalader, Taft, Wickersham
Brandon Becker Dan Hochvert Anthony Saunders
Securities and Exchange Commission NYNEX Corp. New York University
John Behof Brian Hunter Martha Scanlan
Federal Reserve Bank of Chicago American Bankers Association Federal Reserve
Board of Governors
Peter Bennett Jonathan Kalman
International Stock Exchange Securities and Exchange Commission Jeffrey M. Schaefer
Securities Industry Association
Mary Ann Callahan Peter Karpen
International Securities Clearing Corp. First Boston Corp. Robert Schwartz
New York University
James Cochrane Richard Ketchum
New York Stock Exchange Securities and Exchange Commission Joel Seligman
University of Michigan
Andrea Corcoran Thomas Ketchum
School of Law
Commodity Futures Trading EuroClear, Brussels
Commission Donald D. Serpico
Olaf E. Kraulis
Chicago Mercantile Exchange
Richard J. Cowles The Toronto Stock Exchange
Consultant Yuji Shibuya
Wayne Lutheringshausen
Nomura Research Institute
John P. Davidson III Options Clearing Corp.
Chicago Mercantile Exchange Roxanne Taylor
Gerard P. Lynch
Quotron Systems, Inc.
Harry Day Morgan Stanley & Co., Inc.
New York Stock Exchange Paula Tossini
Robert M. Mark
Futures Industry Institute
Dennis A. Dutterer Manufacturers Hanover Trust Co.
Chicago Board of Trade Clearing Corp. Christian Trudeau
Harold McIntyre
Montreal Exchange
Dennis Earle Citibank Financial Institutions Group
Bankers Trust Co. Richard Van Slyke
John W. McPartland
New York Polytechnic University
Susan Ervin Chicago Mercantile Exchange
Commodity Futures Trading Manning Warren III
Commission Morris Mendelson
University of Alabama School of Law
University of Pennsylvania
Giulia Fitzpatrick Robert Woldow
Bankers Trust Co. Thierry Noyelle
National Securities Clearing Corp.
Columbia University
Jane F. Fried
Bankers Trust Co. G.W. Palmer
AT&T Bell Laboratories

NOTE: OTA appreciates and is grateful for the valuable assistance and thoughtful critiques provided by the reviewers and contributors.
The reviewers and contributors do not, however, necessarily approve, disapprove, or endorse this report. OTA assumes full
responsibility for the report and the accuracy of its contents.

vi”
 Contractors

Robert G. Angel Don McNees

Digital Equipment Corp. Peat Marwick, Main& Co.
Eric Clemens Junius Peake
University of Pennsylvania The Peake/Ryerson Consulting Group, Inc.
Robert de Contreras Monica Roman
International Business Machines Corp. Trading Technology, Inc.
Dennis Earle Peter Schwartz
Bankers Trust Co. Global Business Network
Frances Grace Charles M. Seeger III
Editor Chicago Mercantile Exchange
Peter Karpen M arming G. Warren III
First Boston Corp. University of Alabama School of Law

NOTE: ~Aa~=h*mdk~@Mfortivduable=sk~ce andthoughtfulcritiquesprovidedbythecontractors.~e contractors

do not, however, necessarily approve, disapprove, or endorse this report. OTA assumes full responsibility for the report and
the accuracy of its contents.

viii
 Contents
Page
Chapter 1. The Evolution of a Global Securities Market ● 1
INFORMATION TECHNOLOGY FOR GLOBAL MARKETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
THE MEANING OF GLOBALIZATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
COMPETITORS IN WORLD SECURITIES TRADING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
CLEARING AND SETTLEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .* 3
COMPETITION AND REGULATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
THREE SCENARIOS FOR GLOBALIZATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Scenario l: A Cooperative Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Scenario 2: An International Regulatory Regime . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Scenario 3: Conflict and Disintegration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
IMPLICATIONS OF THE SCENARIOS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Chapter 2. Information Technology for Global Markets . . . . . . . . . . . 11
THE EMERGING GLOBAL DATA COMMUNICATIONS INFRASTRUCTURE... . . . . . . . . . . . 11
Public and Private Global Networks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Systems for the Transmissionof Financial News and Market Data . . . . . . . . . . . . . . . . . . . . . . . . . . 13 ●

Electronic Trading Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

TECHNOLOGICAL BARRIERS To 24-HOUR TRADING . . . . . . . . . . . . . . . . . . . . . . . . . . ....*..* 19
THE PROBLEM OF STANDARDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...*... . 19 ●

Chapter 3. The Extent of International Securities Trading . . . . . . . . . . . . . . . . . . .... . . . . . . 23

TRENDS DRIVING GLOBALIZATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .*..*... . . . . 25
Communications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Interdependence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . ● ● 26
Capital Imbalances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Financing National Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Institutional Investors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Regulation and Deregulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ● 28
Privatization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
OBSTACLES TO INTERNATIONAL SECURITIES TRADING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
HOW "GLOBALIZED" ARE SECURITIES MARKETS? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Cross-listing of Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
International Portfolios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Opening National Exchanges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Passing the Book . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Product Links Between Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Multinational Initial Offerings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
International Mutual Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....,.. . . . . . . . . . . . . . . . 35
RISKS INHERENT IN GLOBALIZATION OF SECURITIES MARKETS . . . . . . . . . . . . . . . . . . . . . 35
Chapter 4. Americans Competitors in Global Securities Trading . . . . . . . . . ......... .... ● 37
JAPAN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
Recent Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
How the Market Works . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .,..,... . . . . . . . . . . . . 38
Derivative Products Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
Over-the-Counter Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
Clearing and Settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
Market Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
Tokyo as a World Center for Securities Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
THE UNITED KINGDOM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
How the Market Works . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
Clearing and Settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Market Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
The London International Financial Futures Exchange(LIFFE) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
London as a World Center for Securities Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
THE EUROPEAN COMMUNITY MARKETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
The EC’s 1992 Initiative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
● 49
 Page
Chapter 5 Internationa1 Clearing and Settlement: What Happens After the Trade . . . . . . . . . . . . 55
THE GOALS OF CLEARING AND SETTLEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
HOW CLEARING AND SETTLEMENT WORKS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
RISKS FROM DIFFERENCES IN CLEARING AND SETTLEMENT MECHANISMS . . . . . . . . . 57
EFFORTS TO REDUCE THE DIFFERENCES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
UNRESOLVED PROBLEMS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
POLICY ISSUES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
Risks Associated With Default . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
Risks Associated With the Payment Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
Information Sharing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
Inadequate Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Standardization and Harmonization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Shortening the Time to Settlement and Providing Same-DayFunds . . . . . . . . . . . . . . . . . . . . . . . . . . 68
IS AN INTERNATIONAL REGULATORY BODY NEEDED?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
Chapter 6. The Regulation of Global Securities Trading ... . . . . . . . . . . 71
COMPETITION AND REGULATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
TWO KINDS OF REGULATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
BANKING AND SECURITIES MARKETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
REGULATORY INSTITUTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
ENFORCEMENT OF SECURITIES REGULATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
HARMONIZATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
AMERICAN LEADERSHIP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
Appendix. Clearing and Settlement in Major Market Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
Acronyms and Glossary .. . . . . . . . . .● ● ......... ....,.. ...0..0. 100
Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . ● ..*. 105

Boxes
Box Page
3-A. Exogenous Events and U.S. Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
4-A. EC Securities Law Directives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
6-A. International Organizations Related to Coordination of Securities Regulation . . . . . . . . . . . . . . . . . . . 77

Figures
Figure Page
2-1. Overview of International Trading Through NASD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
3-1. Evidence of the World’s Markets on Oct. 13,1989 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
3-2. Market Capitalization of World’s Stock Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
3-3. Foreign Holdings of U.S. Financial Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
3-4.TradingAroundtheWorldandNearlyAroundtheClock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
5-1. Interfaces Among Clearing Participants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
5-2. Settlement Date:T+? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

Tables
Table Page
3-1. Comparison of Major Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
3-2. Total Cross-National Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
5-1. Group of Thirty: Current Status of International Settlement Recommendations-Equities . . . . . . . . . . 61
5-2. Recommendations From Major International Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

x
 Chapter 1
The Evolution of a Global Securities Market

As national economies are linked together by omies, and thus encourage the growth of securi-
the exchange of goods and services and by ties trading across national boundaries. The
public and private communications networks, rapidly increasing capacity and declining cost of
global securities markets develop. American communications and computer systems make
securities markets, among the world’s best in these trends sure to continue. The emergence of
liquidity, efficiency, and fairness, should stand multinational corporations with presence through-
out in this expanded arena, provided they do not out the world is also hastening the globalization
fall behind in technological and financial inno- of securities markets. The needs of large institu-
vation. But securities trading on a global scale tional investors for cross-national investments
brings with it new risks, as well as beckoning to diversify or to hedge their portfolios is
opportunities. American investors and Ameri- another strong driver.
can regulators and policymakers are seeking to
The technology for global trading is basically
understand these risks and appraise the demands
in place, in the form of public and private
that they will place on markets, market partici-
communications networks, the specialized computer-
pants, and their regulators.
communications systems used for market data
This background paper describes the forces dissemination, and—just poised for take-off—
encouraging the development of international automated systems for ‘round-the-globe, ‘round-
securities markets, the obstacles that must be the-clock trading. The integration of the world
overcome, and the major sources of unnecessary economy means that multinational enterprises
risk. It provides some estimates of the present and their products and services become known
extent of cross-border trading, and describes the to investors throughout the world, reducing the
largest and most active organized markets-our information barriers that have in the past inhib-
competitors in providing securities-related serv- ited international securities trading. Significant
ices—in Japan, the United Kingdom, and the obstacles remain, because international stan-
rest of the European Community. It also de- dards and effective international regulatory
scribes the important clearing, settlement, and protections are not yet developed.
payment mechanisms that support major mar-
kets. Finally, it outlines the questions to be faced The growth in demand for international
as the span of securities trading stretches beyond market news and market data (quotations, last
the scope of national regulatory regimes. sale prices, volume), together with the effects of
the digitizing of data, has led to brisk competi-
This background paper prepares the way for tion among information services vendors, and to
a forthcoming OTA report, Electronic Bulls and a turbulent restructuring of that industry. Elec-
Bears: Securities Markets and Information Tech- tronic trading systems being developed both by
nology, which will probe policy issues arising information vendors and by forward-looking
from the impacts of communications and com- exchanges could become the international ex-
puter technology on traditional market struc- changes of the future. At present, they are
tures and practices, and their ability to meet the essentially unregulated. These changes are forc-
demands implied by global securities trading. ing two issues into new prominence:
INFORMATION TECHNOLOGY FOR . Who owns digitized data at various stages
of its processing and dissemination, who
GLOBAL MARKETS can enforce ownership rights, what consti-
Global telecommunications shrink distances tutes ‘‘value added, ” and how should
and time differences, tie together national econ- digitized data be priced?
–l-
2 ● Trading Around the Clock: Global securities Markets and Information Technology

● Should proprietary trading systems be reg- sponse in other markets to sharp declines in
ulated as organized markets (like exchanges), Tokyo Stock Exchange prices in early 1990, the
and if so, by whom? anxious attention of market observers around
the world attests to the general recognition that
It is by no means certain that U.S. markets
this stability may be precarious.
will remain in the forefront of the movement
toward ‘round-the-clock global securities trad- “Globalization of equity securities trading”
ing. While U.S. futures exchanges and our is a term that covers a variety of related growth
over-the-counter market are acting aggressively trends. It includes the cross-listing of securities
to put worldwide electronic networks in place, in several countries, cross-national portfolio
the U.S. stock exchanges have been slower to diversification and hedging, holding member-
act. Meanwhile, securities exchanges in many ship (generally through affiliates) in another
countries are moving toward highly automated country’s exchanges, legal or contractual ties
markets. between exchanges, electronic systems for 24-
The lack of international standards will be hour trading, “passing the book,” the develop-
increasingly important; for example, standards ment of cross-national stock index derivative
that apply to international financial services, products, and related phenomena such as multi-
national primary offerings of stock and interna-
especially securities trading, need attention
urgently. Government involvement in standards- tional mutual funds. All of these are now
setting appears to be essential if new sources of growing, although at different rates.
operational risk are to be minimized. There are nevertheless major obstacles, such
as legal, regulatory, and cultural differences
THE MEANING OF between nations and markets. Some of these
GLOBALIZATION differences impose serious risks on investors,
market organizations, and other financial insti-
Foreign currency exchange and markets for tutions. These new or aggravated risks are often
government debt securities have long been poorly understood by individual investors and
international. To the extent that there is still perhaps by professional investment managers.
argument about the future of global securities
trading, it focuses on how quickly 24-hour In the worst case, the failure of major market
trading will emerge, and to what degree it will participants (e.g., securities firms or banks) with
extend to corporate equities. A two-tier market heavy commitments in several countries could
system could develop, with international elec- have gravely detrimental results for national
tronic trading of the shares of 500 to 1,000 financial and payment systems and possibly for
multinational corporations, and domestic (coun- entire economies.
try of domicile) trading on traditional exchanges
and over-the-counter markets of most other COMPETITORS IN WORLD
corporate securities. Or—although this is less
likely—traditional exchange-based, face-to- SECURITIES TRADING
face markets could lose out entirely to the Our rivals as centers of international securi-
competition of electronic systems. ties trading today are Japan and the United
There is growing evidence, especially since Kingdom. The potential integration of a Euro-
the October 1987 market break and the October pean securities market, with the European
1989 break, that securities markets around the Community’s 1992 Initiative, will bean impor-
world are linked. They tend to move in parallel tant factor in future competition. Other nations
in response to economic and financial news, and are or may become niche competitors.
to react sharply to stress in other markets. The Tokyo Stock Exchange (TSE) vies with
Although there has been relatively little re- the United States as the world’s largest securi-
 —.

Chapter l—The Evolution of a Global Securities Market ● 3

ties market in terms of capitalization and trading efforts at problem resolution, are in the area of
volume. It has the advantage of a strong clearing and settlement. Clearing and settlement
economy with many multinational corporations, systems for financial instruments differ greatly
a concentration of capital that may exceed within and across countries, in procedures, in
domestic investment opportunities, a large retail timing of settlement, in the institutions in-
customer base, and supportive government pol- volved, and in the degree, nature, and locus of
icy. It is not as ‘‘international’ as London’s risks. These differences in countries’ systems
markets nor as accessible to foreign investors as are important because: 1) systems traditionally
either London or New York, because of regula- used for domestic trading are now being called
tory, institutional, linguistic, and cultural barri- upon to accommodate international participants;
ers. Transaction costs and listing costs are 2) the integrity and efficiency of a nation’s
relatively high. clearing, settlement, and payment system are
important to its internal financial and economic
London’s International Stock Exchange (ISE)
is also among the four or five largest markets stability and its ability to compete with other
nations; 3) the failure of a foreign clearing entity
(usually following the TSE, the New York Stock
Exchange, the Osaka Stock Exchange, and could affect a U.S. clearinghouse through the
NASDAQ, the U.S. over-the-counter market); financial failure of a common clearing member;
and 4) the growing number of U.S. investors in
and it is the most international major market,
with nearly a quarter of its listings and a quarter foreign markets may be unaware that risk levels
in some foreign markets can be much higher
of its transactions involving foreign issues.
However, in the aftermath of deregulation and than those in our domestic markets.
automation—the ‘Big Bang’ of 1986-and the To improve efficiency and reduce risks, the
market crash in 1987, the ISE has serious world’s clearing and settlement systems must be
problems, including the growth of off-market coordinated with each other in a number of
trading that threatens to cause market fragmen- ways. Both the private sector and regulators in
tation. Spreads and commissions, two compo- the United States and other countries have begun
nents of transaction costs, are very low; but to take, or are considering, actions to accomplish
settlement costs are disproportionately high. the needed improvements. A number of interna-
Strenuous efforts are underway to solve these tional studies are in general agreement on the
problems. types of improvements needed. These studies
Other European markets, especially the Ger- have been done by the European Economic
man exchanges, the Paris bourse, and the Swiss Commission, the Federation International des
exchanges, are making vigorous efforts to Bourses de Valeurs (FIVB), the Group of
increase their volume, automate their activities, Thirty, the International Society of Securities
and modernize their regulatory regimes. The Administrators, and Bankers Trust Co. (the last
European Community intends to achieve regula- as contractor to OTA). One of the shared
tory harmonization and an integrated, strong conclusions of these studies is that the world’s
“European trading arena” in services by 1992, major clearing and settlement systems should be
including eventually an integrated European “harmonized” in selected ways in order to
securities market. This is a goal rather than an strengthen them and prepare for the emerging
achievement, and there are many obstacles, but global trading environment.
substantial progress has already been made. The private sector in the United States, with
encouragement from regulators, is making im-
pressive progress in paving the way for needed
CLEARING AND SETTLEMENT improvements, but many are complex, time-
The most critical problems for international consuming, and costly. In some areas legislation
securities trading, but also the most concerted is likely to be needed, e.g., to make it possible
4 . Trading Around the Clock: Global Securities Markets and Information Technology

to eliminate all, or most, physical certificates for cially important because they may involve
securities and to align holidays observed by systemic risks to financial institutions that
banks and financial markets. In other cases, U.S. are involved in the markets of several
regulators will need to take action. countries.
In many cases, U.S. and foreign government There are also important differences in the
cooperation will be needed to effect change. Six activities permitted to certain market partici-
major concerns need to be addressed: risks pants (e.g., separation between banking and
associated with default; risks associated with the securities activities, or separation of broker/
payment process; information sharing; progress dealer functions).
in technology development; standardization;
Differences among nations in regulation of
and shortening the time to settlement using
securities markets are a factor both in risks and
same-day funds. The attention to date by various
in competition among markets. There are sharp
organizations to international clearing, settle-
ment, and payment systems has been helpful, disagreements about the effects of market regu-
but these efforts are unlikely to provide needed lation on competition among markets for cus-
tomers. Some market participants stress that
continuity, and have not addressed all financial
products, such as derivative products (e.g., regulatory costs add to transaction costs, and
oppose most regulation on the grounds that it
stock-index futures and options). Because of the
diversity, complexity, and universality of issues could drive securities trading (both domestic
likely to continue to arise over the next decade, and international) to overseas, less regulated
a single international body should be considered markets. This concern could lead to ‘regulatory
to facilitate world cooperation in addressing arbitrage, ’ or a movement to reduce regulatory
these issues. supervision of markets to the level of that in the
least regulated competitive market.

COMPETITION AND However, there are two broad categories of

market regulation: access regulation, and pru-
REGULATION dential regulation. In most countries, there has
Many complex problems and unnecessary been a movement toward access deregulation in
risks arise from differences between nations in the last few years; i.e., reducing the barriers to
regulations and in regulatory objectives, and broad participation (including foreign participa-
from the lack of international machinery for tion) in organized markets or exchanges, and
monitoring, surveillance, and governing of global this has encouraged internationalization. In
markets. Significant risks associated with inter- some countries, there has at the same time been
national securities markets are related to sub- a movement toward strengthening prudential
stantial differences among nations and markets regulation, or rules aimed at protecting investors
in: against unrecognized risk or against market
fraud, abuse, and manipulation. This is some-
● prudential regulation (i.e., investor protec-
times called "re-regulation, " and it is also often
tion rules, such as disclosure requirements
done for the purpose of attracting investors,
or safeguards against market manipulation
especially international investors. (Neither move-
or fraud);
s capital requirements, accounting practices, ment has been obvious in the United States,
which already had better investor protection
and other factors relating to the financial
laws than many countries, and few if any
integrity of market professionals and inter-
barriers to foreign participation.)
mediaries, brokers, dealers, and traders;
and The problems of enforcing national regula-
● margining systems, clearing and settlement tions are complicated by the difficulty of
mechanisms, and payment systems, espe- investigating and correcting abuses that origi-
 Chapter l—The Evolution of a Global Securities Market ● 5

nate overseas or involve participants outside of our competitive position vis-a-vis global securi-
the country’s borders. In the United States, ties trading.
legislation is being considered that strengthens
the powers of U.S. regulatory agencies to
cooperate with foreign regulators. Cooperative THREE SCENARIOS FOR
efforts are complicated by laws in some coun- GLOBALIZATION
tries that restrict the disclosure of financial data,
i.e., privacy and secrecy laws. These trends suggest several scenarios for
possible regulatory responses to the globaliza-
Free market proponents argue that regulatory tion of securities markets. The scenarios out-
differences between nations are best resolved by lined below are intended merely to focus
deregulation in all nations, letting market forces discussion on the implications of international
and competition decide which risks are accepta- securities trading, and are not suggested as fully
ble to investors. But in most markets and in most developed strategies or policies.
countries, there is a movement toward seeking
“harmonization” of regulations and coopera- The present political, economic, and regula-
tive enforcement of standards of fairness and tory environment for international securities
honesty. Many industry groups and interna- trading consists largely of informal or contrac-
tional associations in the private sector, as well tual institutional arrangements and bilateral
as regulatory authorities in the major market agreements between national regulatory author-
countries, are participating in these efforts. ities. The future regulatory framework for world
markets could be a continuation and extension
However, at the policy setting level and at the of these evolutionary developments; or strik-
negotiating level there are substantial disagree- ingly different frameworks might develop. They
ments about what “harmonization” should could come about as a result of severe market
mean. Even among regulatory agencies in the breaks and disruptive economic and political
United States, there appear to be significant events, or as a result of initiatives shared by
differences in the approach to harmonization of private and public financial institutions and
regulations. There are several different ap- regulatory authorities around the world.
proaches loosely designated as ‘commonality’
(universal regulations); “comparability” (ac- Many forces, acting together at many levels,
ceptance of substantially equivalent rules); “na- could influence such developments. At the level
tional treatment” (each country subjecting do- of the global economy, the process of continuing
mestic and foreign institutions to the same rules economic development is driven by such forces
within its borders); and ‘‘mutual recognition” as the impacts of major economic imbalances,
(a country allows foreign institutions to operate national economic and finance policies, trade
within its borders under the rules of their patterns, inflation rates and interest rates. It will
countries of origin). The last two of these also be shaped by political events-e. g., change
approaches actually do not require, or constitute, in Eastern Europe, the unification of Germany,
harmonization. and the European Community’s 1992 Initiative.
At another level, the evolution of financial
There are several movements underway in- markets will be shaped by the course of
volving either governmental bodies or private technological and product innovation and the
sector associations, or both, to achieve greater behavior patterns of key players—multinational
harmonization. Stronger initiatives by U.S. and translational business enterprises, securi-
governmental agencies may be needed to en- ties underwriters, institutional investors, securi-
courage such efforts, or to assert U.S. leadership ties firms, exchanges, banks, clearing organiza-
on behalf of such efforts, in order both to protect tions, information services vendors, and na-
U.S. investors and institutions and to enhance tional regulatory authorities.
6 ● Trading Around the Clock: Global Securities Markets and Information Technology

The pattern of technological innovation is an broader multilateral regulatory regimes.

important factor in the behavior of securities The OECD is the model of a regional
markets. Innovation in technology and in finan- organization in which the political capabil-
cial instruments could contribute to sustained ity for agreeing on very complex issues can
liquidity and expansion; but it is also possible be developed.
that innovation could outpace the capability of ● Stratified Markets—A two-tiered market
market participants to comprehend and control develops, with the off-market, large bloc
its effects, or could merely be a drain on institutional investors constituting a global
resources and attention without contributing to marketplace and an array of smaller do-
economic utility. Accelerating obsolescence of mestic retail markets.
information technology could diminish the re- ● Global Markets-New technology, the
turn on investment, eventually discouraging global economy, and the commercial strat-
innovation. Financial product innovation can egies of financial companies and their
draw new investment into securities markets or customers and suppliers, drive the evolu-
drive out some traditional investors. Some tion of global financial markets. They
financial innovations (e.g., stock-index futures) develop within a regime of bilateral coop-
have certainly dramatically increased the link- erative agreements, but the world is mov-
ages between different kinds of capital markets, ing toward a 24-hour trading day operating
with secondary impacts that are not yet well- mainly in commercial networks outside of
understood and are the subject of much contro- recognized markets and their regulators.
versy, especially in the United States and Japan. This is, like the Eurobond market today, an
[These forces are discussed in a forthcoming arena for professionals.
OTA report, Electronic Bulls and Bears: Securi-
ties Markets and Information Technology.]
Although many others could be fashioned by
varying one’s assumptions, three possible sce-
Peter Schwartz, of Global Business Network, narios for international securities regulation are
ties together the economic, political, and market outlined below. The first assumes a gradual and
possibilities into five models of international orderly transition from the present. If interna-
securities trading: These are: tional securities trading expands through grad-
● Fragmenting Markets-Conflicts of in-
ual evolution and there are no major economic
terest, political friction, and protectionism
or political disruptions or global market crashes,
inhibit the process of integration of finan-
this is a highly likely scenario; it appears to be
cial markets. Costly and unreliable tech-
the probable one for global securities markets.
nology adds to the burdens on market
But reason and goodwill can be defeated by
participants. Key players see no value in
“accidents of history. ” Disruptions have often
creating an international framework for been the triggers of change, sometimes un-
regulation of securities trading. desirable change and sometimes change for the
● Regional Markets-Integration occurs at
better.
the regional level as part of a protectionist The second and third scenarios acknowledge
world of trading blocs, with diminished the possibility of drastic disruption and disconti-
interbloc trading, and possibly with new nuity. Either of these scenarios could develop if
capital controls. changes in the marketplace outrun the market’s
● Integrating Markets-Multinational trad- ability to adjust, regulate, or even comprehend
ing blocs develop, but are not an impedi- its implications. Either might result from a
ment to global integration. They provide major market disruption, as large or larger than
useful models for complex multilateral the break of October 1987. Such a disruption
economic regimes. Agreements on general might be set off, for example, by a sharp decline
principles are a step along the path toward in the Japanese market, the after-effects of the
 Chapter 1—The Evolution of a Global Securities Market ● 7

bankruptcy of one or two major U.S. securities and the systemic risks associated with them
fins, or changes in currency value related to become more apparent, the pressure for
unification of Germany or other events in some regulatory response mounts.
Eastern Europe or the Soviet Union, or the Economic integration begins at a regional
Japanese real estate market. While a market level and moves toward the global level in
break might begin as an internally caused the first decade of the new century. Coop-
‘‘accident, it is more likely to result from an eration is embodied in the development of
economic environment of weak profits and price the international information systems and
volatility. Continuing economic imbalances, the regulatory agreements required to fos-
widening recession, and the inflationary boom ter increasing integration. Emerging re-
that would likely follow could set the stage for gional blocs are the vehicles for greater
one or the other of these scenarios. global cooperation rather than sources of
conflict.
Scenario 1: A Cooperative Framework
The integration of the European Commu-
A series of efforts, already underway in 1990, nity leads to a closely linked European
leads to the slow development of an effective Market centered in London. Many of the
international regulatory structure. issues resolved in that process became the
● There continues to be a stable, “fairly basis for wider international agreements
(e.g., prospectus standards).
prosperous economy. The industrialized
world enjoys slow but steady and unbroken A major step in the process is the continu-
growth, low inflation, and unemployment ing development, following the path earlier
l
of less than 6 percent. Interest rates follow taken by the Cooke Committee, of the
a somewhat higher path trailing the slow International Organization of Securities
decline in the U.S. fiscal deficit. Interna- Commissions (IOSCO) technical commit-
tional imbalances slowly unwind, currency tee as an effective, permanent organ for
volatility diminishes as a result, and there setting the agenda for agreements and
are no major shocks or disruptions. preparatory steps. The Group of Thirty
o As capital investment in new technology provides continuing encouragement and
increases, and productivity improves, the support. A high degree of collaboration
stage is set for higher growth and accelerat- ensues between private-sector financial
ing investment, placing great demand on leaders and regulatory authorities in the
international capital markets. A continuing major market countries.
bull market supports a climate of sustained During the 1990s a new regulatory frame-
financial innovation. Today’s multi- work gradually emerges out of the slow
domestic markets with limited interna- accumulation of bilateral agreements, or
tional activity move toward ever more Memoranda of Understanding (MOUs).
international flows. This is a very modest regulatory regime,
● The true global marketplace begins to with limited overt organization.
develop in the off-market trading arena Through the collaborative actions of these
used by large institutional investor/ several bodies a schedule of agreements
professionals. As the structure of markets emerges focusing initially on the risks
gradually becomes ever more stratified, associated with settlement and common
lb the lg70~ ~ ~ge ~mr of foreiw m~~tio~ ba~ si~ted ~ ~ndon s~~ ,sw~~ serious concerns: over disparities h WCOU.Uthg
standards, over who would act as lender of last xesort if one of these branches failed, etc. The Bank of England proposed the establishment of an
international Standing Committee of regulators, established in 1974 [now called the Cooke Committee after its chairmam Peter Cooke]. The Standing
Committee developed the Basle Concor&G a set of international principles for handling a banking crisis. The concept here is that the technical committee
of IOSCO (already established and working) or a similar permanent committee of anotherintermtional organization might quasi-formally assume many
of the coordinating functions of an international regulatory body.
8 ● Trading Around the Clock: Global Securities Markets and Information Technology

conditions for capital adequacy. The issues higher growth and increasing integration of
of futures markets and questions of multi- the global marketplace.
ple listings and multinational share offer-
ings are slowly resolved. Common ac- Scenario 3: Conflict and Disintegration
counting standards take even longer. A break occurs, as a result of a fundamental
currency reevaluation crisis, that is severe
Scenario 2: An International enough to seriously erode confidence.
Market discontinuity and economic down-
Regulatory Regime
turn lead to increasing friction rather than
The average growth rate might be slightly cooperation. Slower recovery and a bear
lower or slightly higher than in the cooper- market result as there are vicious cycles of
ative framework scenario, but economic mounting damage.
variables swing widely. Exchange rates, Market growth slows dramatically or re-
interest rates, and inflation rates interact in verses, and becomes more volatile. There
a period of flux driven by unmanaged is widespread loss of confidence. Lack of
imbalances and cascading shocks. resources and motivation are almost insur-
Some event—a severe earthquake in New mountable barriers to innovation.
York or Tokyo, a financial scandal in Efforts for international regulatory cooper-
London’s Eurobond market-triggers a ation wither quickly.
general crisis in already stressed securities
markets. IMPLICATIONS OF THE
The major market disruption creates the SCENARIOS
political will to establish an institutional
regulatory regime at the international level, Effective response to a major securities mar-
although none of today’s international ket break will in the future require international
financial institutions, such as the World as well as domestic actions. The central issue
Bank, the IMF, or the Bank of International may be how to prevent a liquidity crisis from
Settlements, or IOSCO, provide a com- becoming a solvency crisis. This requires a
pletely adequate model. better understanding than we have now of how
Galvanized by necessity, nations act rap- large a market break could occur, how and why
idly and effectively to set up a new it might happen, and how to restore confidence
institution and enforce its decisions. U.S. afterward. In some markets, there may also be
Government and private sector representa- unexamined risks of overstraining key systems
tives play a leading role in the negotiations. (e.g., clearing and settlement) in a roaring bull
The U.S. Congress articulates a forceful market. These uncertainties are probably as
policy of support for the new institution; at poorly understood as the risk of a major market
its instructions, the regulatory agency be- break.
gins a rigorous assessment of markets- International securities markets may be mov-
related laws, regulations, procedures, and ing toward a structure that is efficient, stable,
policies to identify necessary changes and and adequately well-regulated. This outcome is
adaptations. likely if there are no cataclysmic changes from
The economic volatility does not inhibit today’s situation, either generated internally (by
technology-based investment, but actually behavior of the participants, or by failure of
accelerates change as the downswings basic market structures) or generated by macro-
facilitate the write-off of obsolete capital economic events outside of the markets. As
and the upswings support new investment— internationalization continues, it will be impor-
Schumpeter’s model of “creative destruc- tant to deal with the perils of “regulatory
tion.’ A volatile early 1990s leads to arbitrage’ if competition tempts participants to
 Chapter I—The Evolution of a Global Securities Market ● 9

move trades to the cheapest, least regulated minimum, Congress will be called on for
markets. oversight and guidance of U.S. regulatory bod-
It is increasingly likely that there will be a ies and executive agencies—the Securities and
stratified or two-tier market structure. This Exchange Commission, the Commodity Futures
could mean a divergence of interests between Trading Commission, the Federal Reserve Bank
the large, wholesale, institutional, global trans- Board of Governors, and the Department of the
action market and the domestic, retail market. Treasury, all of whom will be involved in
What have been considered off-market activities framing the position of the United States in the
(nonorganized, negotiated trading on proprie- evolution of an oversight, supervisory, or regu-
tary systems, perhaps unregulated) may come to latory regime for international securities trad-
dominate global equity markets for the securi- ing. It is not clear that these authorities now hold
ties of at least 500 to 1,000 translational or a common view of the interests of the United
global companies in the future. States with regard to either: a) the kinds of
aggressive actions and innovation needed to
The central problem will become one of compete in offering services and products to
systemic risk. Will there be a lender of last investors around the world, or b) the degree of
resort? Will the real risks devolve onto commer- risk inherent in international trading and the
cial banking systems, and national payment desirability of working with other nations to
systems? How can volatility in the global , develop a stronger regulatory regime to reduce
market be kept from cascading onto domestic these risks.
markets, where the consequences might be
greater? How can the global economy be In this critical situation, it may be necessary
protected from excessive risk from the unregu-
for the U.S. Congress to articulate a clear
lated international securities market?
statement of the national interest for the guid-
It is clear that the U.S. Congress will neces- ance of regulators, as it did in 1934 with the
sarily have a critical role to play with regard to Securities Exchange Act, and in 1975, with the
the globalization of securities trading. At a Securities Exchange Act Amendments.
 Chapter 2
Information Technology for Global Markets

Four forces have caused international securities . satellite communications development; and
trading to increase: ● fiber optics development.
advances in information technology-telecom-
munications and computers; Improved computer performance and declining
the development of a global economy with costs have resulted from improvements in basic
multinational corporations needing both inter- computer technology, very large-scale integration
national communications and international sources (VLSI) technology, materials (e.g., use of gallium
of capital; arsenide in production of chips), and computer
the emergence of huge institutional investment architectures and software.3 In 1960, it cost about
funds needing cross-national diversification; $75 to do 1 million computer operations; in 1980 it
regulatory changes, especially access deregula- cost 0.1 cent. By 1997 computer costs are expected
tion that opened stock exchanges to foreign to decrease still further. Computers make it possible
membership in many countries. to use telephone systems to transmit, store, and
distribute electronically encoded information; they
The technology for international securities trad- also control the switches that route information
ing is in place, and its capabilities will continue to through a network.
increase. The emerging global communications
infrastructure has evolved at three levels: 1) public “Digitizing’ is the translation of information
and private communication networks using cable, from traditional analog forms such as pictures,
microwave, and satellite transmission; 2) communi- speech, or written/printed characters, into discrete
cations technology used by providers of market binary-coded electronic signals for processing, stor-
information services; and 3) specialized electronic age, or transmittal. This makes possible the fusion of
securities trading systems. telecommunication and information-processing tech-
nologies. It allows man-to-machine communication
THE EMERGING GLOBAL DATA not possible with a conventional telephone, and has
prompted the carriers to build multi-media commu-
COMMUNICATIONS nications systems by combining facsimile, data, and
INFRASTRUCTURE video with voice transmittal capability.4 Since the
International securities trading requires a system 1970s, AT&T, MCI, Sprint, and other communica-
for efficient, rapid, and secure transmission of tions carriers around the world have been upgrading
market data, transactions messages, and payment their existing networks to high-capacity digital lines.
instructions. The infrastructure to do this has devel-
Fiber-optics Provides broad bandwidths that allow
oped rapidly over the last 25 years and is continuing
the transmission of high-speed video images as well
its turbulent development. Four technological trends
as the capacity to move large volumes of data.
contributed to this development:
Development of broadband integrated services digi-
. expanding computer capability and declining tal networks (B-ISDN) can eventually provide
costs; efficient broadband interconnection for all commu-
● digitization of data, and the resulting conver- nication services-transmitting voice, data, video,
gence of computer and telecommunications and text. ISDN is still in the early commercialization
technologies; stage.

l’rhis ~tion tiWS l.KXWiIy on an CZ@SI OTA repo~ U.S COngreSS, Office of Technology Assessment critical connections: CO?t??WnicUZiOnfOr
the Future, O’E4-CIT-407 (Washington DC: U.S. Government Printing Office, January 1990), especially ch. 3, “New Technologies and Chan@ng
Interdependencies in the Communication Infrastructure.”
WL.SIkllows the placement of over 100 logical oprmtions on a single integrated circuit chip, a capaMMy that has been doubling about every 18 montbs.
%J.S. Congress, OTA, op. cit., footnote 1, p. 46.
4u.s. Cowess, OTA op. cit., footnote 1. See also, Tosh.io Kosuge, “Telemmmunications,” in Peter Robinso~ Karl P. SauvanC and Vishwas P.
Govitrikar (eds.), Electronic Highways for WorZd Trudk (Boulder, CO: Westview Press, 1990), pp. 223-238.

–11–
12 ● Trading Around the Clock: Global Securities Markets and Information Technology

These developments shape all parts of the com- theless, there is some danger that network interde-
munications infrastructure: 1) switching or network- pendence may slow innovation, because once users
ing technology; 2) transmission technology; and 3) have invested in equipment conforming to a particu-
terminal technology.s Switching technology con- lar standard, they will be reluctant to purchase
sists of computer hardware and software for routing equipment that is incompatible even if it is otherwise
messages and establishing a communication chan- superior. 8
nel, and thus provides the “intelligent” part of the
network. Manual switches and electronic analog Public and Private Global Networks
switches are being replaced with digital switches.
Telecommunication services are provided in many
Some superfast packet switches6 can now transmit
countries by state-owned monopolies, that typically
hundreds of thousands of packets per second; by the
use INTELSAT and regional satellite and cable
late 1990s, with optical switching, even greater
facilities to transmit international communications.
speeds will be practical. Software development will
In the United States, telecommunications have
determine the rate of further improvements in
traditionally been provided by government-
cost/performance ratios.
regulated private-sector fins. The United King-
With more powerful microprocessors, faster com- dom, Japan, Hong Kong, and other countries are
puting speeds, and larger memories it is now moving toward private or private-government sys-
possible to put control functions for the network not tems.9 A user in one country who wants to connect
only in the central switch, but also at. nodes with an online database in another country most
throughout the system. This software-driven and often does so with a modem (a device that allows
software-defined communication infrastructure-- digital signals from a computer to be transmitted
“the intelligent network’ ’encourages the intro- over analog telephone lines), through a long-
duction of new value-added services using modular distance telephone connection. Telephone compa-
software. nies in different countries pass calls along through
interconnections across different technologies-a
Keeping pace with advances in switching technol- message often travels through microwave, satellite,
ogy are advances in transmission technologies: and cable transmission facilities.
optical fiber or coaxial cable and radio or broadcast
technology, which includes satellite, microwave, Public telephone systems have encouraged the
and for local use, cellular broadcast communica- development of computer networks. A computer
tions. Customers usually do not know or care how network is a collection of computers-whether
the message was transmitted, but differences in these minicomputers, mainframes, or supercomputers—
technologies result in major differences in the type that communicate with each other using common
of electronic signals that can be transmitted, the protocols, over transmission links that can be cable,
quality of transmission, the range of frequencies that satellite, or ordinary telephone lines. The networks
can be used, the speed of transmission, the confiden- may be local area networks (LANs) or long-distance
tiality and security of the transmission, and the cost.7 networks (wide area networks, or WANs). They
allow any computer in the network to access and use
Terminal equipment is that found at the customer computer programs or data stored on any other
end of the network, usually telephones or computer network computer.
terminals. Many of these terminals now contain
information-processing capability. In the United States, the unbundling of some
communication services and the divestiture of AT&T
Advances in global communications infrastruc- have encouraged business users to assemble their
ture technologies will probably accelerate. Never- own networks. Deregulatory changes encourage the

5Komge, op. Cit., footno~ 4“

6p~&e~.~fitc~~y~tem dividc~s~~nl~~gesinto~y Shortblocks orpackcts tit c~~rollted independently throughnummus geographically
distributed switching nodes.
7GR~ Feketekuty, *’International Network Competition in Telecommunications, “ in Robinson et al., op. cit., footnote 4, pp. 257-287.
W.S. Congress, O’IA, op. cit., footnote 1, p. 43.
%. Brian Woodrow, “Trade in Telecommunications and Data Services: A ‘Constitutional’ Analysis,” m “ Robinson et al., op. cit., footnote 4, pp.
15-42.
 Chapter 2--Information Technology for Global Markets ● 13

unbundling of services by allowing users to sepa- have normally used established monopoly transmis-
rately purchase communication services or functions sion arrangements, but alternative distribution pos-
that were formerly available only as a single unit (the sibilities are opening up; for example, domestic
kind of end-to-end service once offered by the satellite providers in one country may sell cross-
AT&T Bell System). Unbundling has encouraged border capacity or specialized services in bordering
the development of value-added services, and may countries.
be carried further by the development of “open
These developments are strongly resisted by the
network architecture” (ONA), which allows service
government-controlled public telephone and tele-
providers to buy elemental network functions and
graph authorities (PTTs) in European and Third
reconfigure them to meet their particular needs. True
World countries. In some countries there are restric-
ONA requires further advances in software develop-
tive laws governing the use of communications
ment, and it may in the end not be acceptable to all
technologies and systems to protect the state monop-
users because it transfers to them the problems of
oly. Such legal, regulatory, and political barriers will
network planning and management.10
be serious problems for some time, although there
A striking feature of modern global telecommuni- are strong indications that these barriers are breaking
cations is the development of private networks to down because communication is essential to compe-
serve the needs of individual translational enter- tition in today’s world economy. Foreign competi-
prises. Once data are digital, corporate networks tion tempts corporations to move their activities to
allow translational corporations to perform corpo- other countries, where business conditions are more
rate functions in any country. Many large financial favorable.
institutions like Citibank, American Express, Salo-
mon Brothers, major stock exchanges, and other
Systems for the Transmission of Financial
kinds of multinational corporations such as IBM, 13

Digital Equipment Corp., Unisys, General Motors,

News and Market Data
and Britain’s Imperial Chemical Industries, have Communications between exchanges, over-the-
developed their own networks, using satellite capac- counter markets, and clearing organizations in
ity and transmission lines leased from communica- different countries, as well as communications
tion companies. IBM, for example, has “a global between investors and their brokers in one country
communications network that ties together its instal- and markets in other countries, are for the most part
lations in 145 countries. There are also privately handled through the same communication modes
owned data networks that serve many corporations, used by other business enterprises-i.e., leased
such as Telenet Communications. transmission lines. A portion of these communica-
tions are handled by specialized information serv-
Digital data and the declining costs of telecommu- ices vendors. The rapid, broad dissemination of
nications have resulted in a proliferation of informa- market data is an essential element in making
tion services providers, and in the development of securities markets both efficient and fair. It is largely
closed user-group networks—i.e., SWIFT,ll and accomplished today by information services ven-
Reuters Limited, the international news service. dors using a variety of public communication
modes.
Global networks are “making previously untrada-
ble services tradable.” In the past, vendors could Advances in technology and restructuring of its
offer such services in the foreign market only costs are having a profound effect on the structure of
through foreign affiliates.12 Data services, which the information services industry. They may induce
make use of international telecommunication cir- vendors to move into more specialized, value-added
cuits, are offered in many countries on a competitive services. It is possible that systems being developed
and unregulated basis. International data services by the vendors for their own competitive reasons

lm.s. Congress, OTA, op. cit., footnote 1.

lls~ s~d~ for Swiew for Worldtide ~ter~nk Ffinc~ Telecommunications; it is a system ~OW@ bx and other fmnc~ kLStihltiOllS,
including brokerage fins, to exchange payment instruction or clearing messages.
12-1 p. sauva~ ~~semices and Dab Semi@s: ~troduction, “ in Robinson et al., op. cit., footnote 4, pp. 3-15.
13~s sation &aws on a ~n~actor repo~ prepa~ for OTA by MoniM Ro~ “F~c~ ~o~tion semic~ Vendors,” August 1989.
14 ● Trading Around the Clock: Global Securities Markets and Information Technology

could become the real international exchanges of Dow Jones & Co., Inc., is the leading provider of
tomorrow, as markets become more global, and financial news in the United States, but Reuters has
computer-based trading and telecommunications an edge over Dow Jones in financial news that
become strategic advantages. Vendors are ahead of affects forex and freed-income prices because of
exchanges in preparing to field global electronic Reuters’ vast international communications net-
trading systems. However, vendors will have to work. Other providers of on-line financial news
work out interfaces with clearing and settlement and include Knight-Ridder, Associated Press, McGraw-
other systems (see ch. 5). Hill Inc., Financial News Network, and Market
News Service.
As early as 1850 there was a market for interna- Quotron Systems has long dominated the market
tional financial information services; Paul Julius for U.S. stock market data, but ADP is a strong
Reuter began using carrier pigeons to fly stock competitor. Outside the United States, the leader is
market quotations between Brussels and Aachen, Reuters (based in the United Kingdom), which
Germany. The opening of the first underwater recently entered the U.S. market for stock prices. In
telegraph cable in 1851, connecting Dover and the past, Reuters supplied market data and news for
Calais, allowed Reuter to start delivering market foreign exchange, money market instruments and
data and financial news from London to Continental commodities in the United States, but not for
Europe. Because of high start-up and low marginal equities. The internationalization of the securities
costs, vendors could be more efficient than user markets has prompted foreign vendors such as
firms in information gathering (as is still true today, Reuters and Telekurs of Switzerland to enter the
for the most part). The company Reuter founded, U.S. market. The relative ease of acquiring and
Reuters Holdings PLC, is now one of five companies distributing price information for exchange-traded
that dominate the market for securities and futures instruments has also attracted new competitors,
market data (prices and quotations). The other four including PC Quote Inc., and ILX Systems, a new
are Quotron Systems Inc., Automatic Data Process- venture backed by International Thomson Organiza-
ing Inc. (ADP), Telerate Inc., and Knight-Ridder tion.
Inc. 14 These five companies have approximately
400,000 terminals worldwide.15 At the same time, U.S. companies such as
Quotron and ADP have been expanding their
operations overseas. The growing interrelationship
The market for financial information can be
among the equities, futures, freed-income, and
divided into three broad categories: 1) general
foreign exchange markets has also led to diversifica-
financial news,2) quotes and sale prices for exchange-
tion among vendors who traditionally specialized in
traded instruments, and 3) quotes and prices for
one market. Telerate Inc., which holds a near
over-the-counter instruments. (The latter two are
monopoly in the market for U.S. Government
different markets because the sources of data are
securities prices, has entered the equities market
different, and because of differences in trading
through its recent acquisition of CMQ Communica-
practices and trading technology.) Financial infor-
tions Inc., the leading provider of stock quotes in
mation vendors either gather general financial news
Canada.
themselves or select and carry reports from leading
news organizations. Quotes (bids and offers), last- The relative ease with which any vendor can
sale prices, and volume information-including obtain data from the leading North American stock
those for most stocks, all commodity and financial markets and many of their foreign counterparts has
futures, and all options-are generated by markets changed the market for centralized market trade data
and sold to vendors. In foreign exchange (forex) and into a commodity market, in the sense of relatively
fixed-income (bond) markets, where there are no undifferentiated bulk goods, competing in terms of
centralized marketplaces, price information is con- price. It has increased the competition among
tributed by banks and securities firms to vendors. vendors so much that in order to maintain their profit
14@o&on is now ~m~ by Citimw; Tel~@ is now o~~ by ~W Jones & CO., hc., Iong Tel~mte’s majority shrth)ld~.
15~ ~~ly 1989, 42G,~ were ~~po~ ~~o~ding to MC ~o ~d K~eth Ng, Reuters Holdings pm (New York NY: (hlb~ saChS & CO,,
February 1989), p. 5. There maybe some double counting here due to screens displaying more than one vendor’s data, and there has probably been some
contraction due to securities f- reducing their labor force.
 Chapter 2--Information Technology for Global Markets ● 15

margins and to generate as much revenue per tion vendors. As recently as 5 years ago, a dealer’s
terminal as possible, vendors are trying to add value desk would typically hold a Reuters terminal and
to the product through new technology or some perhaps one from Telerate. Because markets did not
special feature. Third-party suppliers are now en- greatly affect one another, there was no need for
couraged to offer historical information, research, most traders in one market to be watching other
analytics, and tailored news services through the markets .18 The technology generally used was a
terminals of financial information vendors such as dumb terminal connected to a vendor’s host com-
Quotron, Reuters, and Bridge. The vendors typically puter by dedicated telephone circuits. But as a
keep for themselves 30 to 40 percent of the revenue number of niche services sprung up, traders ended up
generated by third-party products. l6 with more and more dedicated terminals on their
desks. Many of these were later replaced with
The commodity or bulk nature of equities trade personal computers, to allow local storage and
data has no parallel in the fried income and foreign manipulation of price information. The video switch
exchange markets, which depend on data contrib- eliminated the clutter of terminals on traders’ desks
uted by dealers, banks or other organizations. But by allowing several screens to be controlled by a
the largest securities firms have announced plans (at single keyboard, and became an important part of
the end of April 1990) for a joint venture to distribute trading rooms in many countries.
government bond data 24 hours a day. This network
would include all 844 primary bond dealers and four
Several other technological advances in the early
major interbroker dealers, who execute trades for all
and mid- 1980s also irrevocably changed the deliv-
dealers,
ery of financial information. In addition to using
Reuters created the market for real-time foreign dedicated telephone lines, vendors began exploring
exchange data in 1973, when it first put computer other alternatives, such as broadcasting data by FM
terminals on the desks of banks’ traders and per- sideband and satellite. In the United States, com-
suaded them to enter their rates into the system. modity market data vendors began in 1981 to use
Reuters does not pay banks for contributing their small, low-cost, receive-only satellite dishes which
quotes to the service, but charges subscribers a flat were particularly effective for one-way broadcast
monthly fee. While Reuters is the strongest in the communications such as financial quotations. They
forex market, Telerate is a competitive alternate are now used by vendors such as ADP, Dow Jones,
service. This benefits forex traders by providing a Knight-Ridder, PC Quote, Reuters, and Telerate.
back-up quotation system and by assuring competi- Although dedicated interactive networks remain the
tion for Reuters. It was difficult for Telerate to gain primary delivery mechanism of financial informa-
a place in forex until Reuters agreed to permit its tion vendors, financial data accounts for about 63
subscribers to install “binco boxes" —bank in- percent of the approximately 114,000 data broad-
house computers—that let them simultaneously casting satellite receiving sites in operation in
update their rates on Reuters and Telerate. Without 1989. 19
the binco boxes, Telerate’s forex market coverage
was often slightly behind because dealers posted It is often cheaper for securities firms to buy
their rates on Reuters first.17 hardware off the shelf than it is for them to lease
equipment from vendors. In addition, the securities
The financial information business is still grow- firms want to be able to choose whether to use a
ing, and continues to attract aggressive competitors. dumb terminal, a PC, or a UNIX-based workstation,
This may eventually bring down prices for informa- and they would like industry-standard hardware that
tion services. In the meantime, both the integration can be integrated with the fins’s other systems. In
of markets and technological change are creating recognition of this, Reuters recently stopped manu-
upheaval and uncertainty among financial informa- facturing terminals and Quotron plans to sell off-the-

16Roq op. cit., footnote 13.

170~m-~jor mom for Tel~atess ~Wss fi ~e~afig tie forei~ exc~nge ~ket we s~d tO include two foreign exchange brokers ~ging
for Telerate to carry their quotes, the availability of AP-Dow Jones foreign exchange news on Telerate, and the need for U.S. Merest rate data.
18Howwer, fie&~ome ~ders~ways~ven~~ to follow tie fore @ exc~WeWkets since currency pric~ ad intemstrates ~cIosdyhlkd.
19wate~ Info*on StXViCeS, “DataBroadcasting Marketplace,” New Yorlq NY, 1989.
16 ● Trading Around the Clock: Global Securities Markets and Information Technology

shelf equipment. ADP is also moving to industry- Reuters launched the Monitor Dealing Service in
standard hardware. 1981 to allow forex traders to negotiate transactions
over their terminals instead of telephones. This
Vendors have begun to offer their data in digital,
system has been successful, perhaps in part because
as well as analog form, to satisfy the demand for
of its built-in audit trail. In 1989, between 30 and 40
analytical tools. Receiving a stream of digital data
percent of the $640 billion traded each day in the
(rather than a pictorial image on screen) gives users
interbank foreign exchange market took place on the
more flexibility in viewing, analyzing, and using
Monitor Dealing Service.20
data--e.g., the ability to create customized compos-
ite pages. This has created a dilemma for financial Telerate did not until recently offer forex dealers
information vendors because neither exchanges or a transactional system such as Reuters’ Monitor
vendors are sure how best to price digital informa- Dealing Service, but it has now launched a conversa-
tion. tional, or on-line, dealing system through a joint
This has become a highly controversial issue: who venture with AT&T, known as The Trading Service.
owns the data, who has access rights to it, who can This service allows dealers to have multiple “con-
reformat and resell it, and when does reformatting versations, ” that is, talk to several dealers at once,
constitute value-added service? The fees paid by unlike the Monitor Dealing Service.
customers have in the past been based on the number Reuters is taking another step forward in auto-
of terminals or display devices authorized to receive mated trading with an enhanced version of the
information in analog form. Resolving the data- Monitor Dealing Service and a centralized order
pricing issue will become more complicated and database facility. While the original Dealing Service
more difficult as international data services become facilitates one-on-one negotiation between two trad-
even more fiercely competitive. ers, Dealing 2000 will emulate an auction market
where bids and offers from multiple parties are
Electronic Trading Systems exposed. This is designed to replace ‘‘blind”
brokers, who act as middlemen in foreign exchange
The commodity nature of data and the diminished trading. The system will display the aggregate size
role of information vendors as systems providers are of all bids and offers at each price, but will not
causing vendors to move toward offering transac- disclose the identities of the dealers participating.
tional services, using automated execution systems,
Citicorp and McGraw-Hill failed with the GEMCO Quotron has not moved as rapidly as Reuters, but
electronic commodity trading system a few years reportedly has electronic execution facilities in
ago. The World Energy Exchange and the Interna- development for both foreign exchange and fixed-
tional Futures Exchange of Bermuda (INTEX) both income markets. It has been aggressively marketing
failed to convert open outcry traders to screen-based Currency Trader, which allows corporate customers
trading in the futures market. But these and other of Citicorp to automatically execute foreign ex-
failed ventures in automated trading have not change trades of $500,000 or less.
deterred Reuters, which in 1987 bought Instinct
Whether the foreign exchange market will accept
Corp., a registered broker/dealer offering an elec-
the automated trading Reuters is offering through
tronic securities trading system that began in the
Dealing 2000 is still uncertain, but the technology
1970s. Instinct is now executing trades of an average
used in that system was adapted for GLOBEX, a
of 13 million shares a day (including both NYSE-
futures trading system being jointly developed by
listed and over-the-counter stocks), a volume still
the Chicago Mercantile Exchange (CME) and Reu-
tiny by comparison with the approximately 273
ters.
million shares traded by the New York Stock
Exchange and NASDAQ together on an average CME is one of two Chicago futures exchanges
day. Reuters hopes, however, that exchanges will trying to develop systems for ‘ ‘24-hour trading,’ or
begin using Instinct or another Reuters-developed the execution of transactions at a geographical
system during the hours when their trading floors are distance or outside of trading hours of local markets,
closed. CME and the Chicago Board of Trade (CBOT) first

~ank of International Settlement’s statistics.

 Chapter 2--Information Technology for Global Markets ● 17

separately and now jointly, are taking the calculated GLOBEX. 22 On June 20, 1988 in London, England.
risk that their own automated system--if successful-- the CME and Reuters Holdings PLC reached an
may eventually put out of business their traditional agreement to adapt the new Dealing 2000 transac-
form of market, the “open outcry” or pit auction tion system for the purpose. The network will
system. They may recognize the likelihood that operate only after normal CME hours of trading and
international markets will eventually be fully auto- will link investors in North America, Asia and
mated and free of the constraints of time and Europe.
distance, and know that if they do not take the lead,
others outside the industry will do so. GLOBEX, when it opens in mid-1990, will be an
interactive data communications network linking
This has come about because foreign futures
individual user terminals with a central computer at
exchanges began to compete directly with U.S.
Reuters. For entry of orders, trader terminals consist-
futures exchanges. There are financial centers in
ing of keyboard, monitor. and printer will be located
Auckland, London, Paris, Frankfurt, Zurich, Hong
in the offices clearing members and individual
Kong, Tokyo, Singapore, and Sydney which now
members (including overseas members) who are
operate futures and options exchanges as well as
qualified and backed by a clearing member. (See ch.
stock exchanges. Because they began to offer their
5 for an explanation of the responsibility of clearing
own local versions of U.S. contracts, investment
members.) Administrative terminals, in the offices
firms were able to offer these products to customers
of clearing members only. would also receive
without regard to trading hours in the United States.
confirmations of all trades resulting from orders
This trend drove the threatened exchanges to con-
entered into associated trader terminals. The termi-
sider accommodating 24-hour trading. 2l
nals will display the 10 best bid and 10 best offer
The first attempts to meet this competition took prices, along with the quantity bid or offered; the last
the form of mutual offset agreements. such as the sale price, and other data.
one between The Chicago Mercantile Exchange
(CME) and the Singapore International Monetary Reuters will provide the computer hardware and
Exchange (SIMEX) for Eurodollar and foreign software and also make available other Reuters
currency contracts. ‘‘Offset’ (in this context) means services (e.g., news and cash market quotations)
that one can open a position in one country and close through GLOBEX terminals. The exchange will
it in another, and pay only one brokerage fee. determin e the instruments. and the rules and proce-
CME/SIMEX was for a time one of the most dures for trading, and will provide clearing facilities.
successful of the many offset agreements attempted auditing, compliance, and market surveillance, De-
by exchanges, although only marginally so. spite Reuters being a British company. the joint
effort is largely seen as a globally strategic move for
Another response was to lengthen trading hours;
for example, CBOT began both an earlier opening the preservation and enlargement of the U.S. posi-
tion in commodities and financial futures trading, It
(7:20 a.m.) and an evening session,
may also be a harbinger of global ● floor-less* ● ●

In September of 1987, the CME announced that it trading in the future. It is significant, however. that
would develop-together with Reuters-an elec- Reuters has recognized the value of partnership with
tronic futures and futures-options trading network, an organized and regulated marketplace, the futures
the Post (Pre) Market Trade System, later renamed exchange.
GLOBEX for “global exchange. ” CME members
accepted the idea, with the assurance that GLOBEX MATIF (the French financial futures exchange)
was strictly an off-hours system, and in return for has already agreed to use GLOBEX for after-hours
receiving a portion of the revenues generated by trading, and exchanges in other countries are also

‘lKaren Fierog, “How Technology Is Tackling 24-hour Global Markets,’” Furures, June 1989, p. 68.
‘The rights conferred by membership inCME, or “a sea~” are to be divided into access to pit trading and access tohd.ng through GLOBE.X.
Members will have the right to “lease” one of these rights; e.g., a pit trader can lease to someone else, presumably overseas. his access to GLOBE.X
thus generating additional income. If GLOBEX (or other electronic trading s>xtems) comes to domina te futures trading, the increase in value of their
access to it will pre sumably compensate the pit members for this competition.
18 ● Trading Around the Clock: Global Securities Markets and Information Technology

expected to participate, when various regulatory but is growing, and LIFFE may soon list thinly
issues are worked out.23 traded contracts only on APTS. The system is used
now to extend trading hours to cover the European
In 1989 the CBOT unveiled plans for another
trading day, but it is not a 24-hour system and will
off-hours global system, “AURORA.” While the
not be available outside the United Kingdom. LIFFE
GLOBEX system is an automatic order matching
says that the cost of high-speed communications
system, AURORA attempts to emulate the traders in
links for worldwide trading is prohibitively high.25
the pit with icons (symbols) that allow traders to
However, this could change if the LIFFE system
select the counterparts to their trade. The CBOT
proves popular.
claimed that AURORA will capture ‘‘all of the
economic advantages of the auction market com- There are also automated trading systems at the
bined with the advantage of the ability to conduct Irish Futures and Options Exchange, the London
trading from any location in the world." 24 One Futures and Options Exchange, the New Zealand
interesting feature of both AURORA and GLOBEX Futures and Options Exchange, the Sydney Futures
is that they adjust the timing of all bids and offers to Exchange, the Tokyo Grain Exchange, and the
equalize for distance; i.e., the speed with which they Tokyo International Financial Futures Exchange.
are posted depends on the transmission time for the These trading systems, like those in stock markets,
most distant trader active at that time. were not designed for 24-hour trading, but possibly
AURORA also tabulates bids and offers by could be adapted. Some of them were specifically
contract month, reports who traded how much with designed for trading after exchange-hours.
whom, and keeps a running tabulation of his Reuters’ success in recruiting exchanges to use its
positions for the trader. It automatically sends automated trading facilities is not limited to the
matched trades through for clearing by the Board of futures market. The Chicago Board Options Ex-
Trade Clearing Corp. The system uses Tandem change and the Cincinnati Stock Exchange have
mainframe computers, Texas Instrument artificial agreed to form a joint venture with Reuters and
intelligence components, and Apple computer graph- Instinct to create a worldwide system for entering,
ics.
routing, and executing options listed on the CBOE
There were complaints from the financial futures and equities traded by the Cincinnati Stock Ex-
community about the need to install two terminals, change, the only fully automated securities ex-
and in May 1990, immediately after the Japanese change in the United States.
Ministry of Finance announced that it would permit
The New York Stock Exchange recently an-
Japanese firms to subscribe to GLOBEX, CME and
nounced its intention to study the feasibility of
CBOT announced they would merge the GLOBEX
off-board 24-hour trading systems. The over-the-
and AURORA development efforts. The details of
counter dealers represented by the National Associa-
this agreement are not yet negotiated. AURORA
tion of Securities Dealers (NASD), plan to extend
may survive as an optional user interface. The
their automated quotation system, NASDAQ, to the
operation of GLOBEX may be delayed until mid-
1991. United Kingdom, allowing NASD members both in
the United Kingdom and in the United States to
The London International Financial Futures Ex- make markets in several hundred issues during
change developed an electronic trading system, normal U.K. trading hours, and to use NASDAQ
Automated Pit Trading System or AFT, which like services during the-se hours. If approved by the
the AURORA system, emulates open-outcry trad- Securities and Exchange Commission, the system
ing. APT is now trading about 4,000 orders a day, will be open from 4 a.m. to 4 p.m. eastern time (9

~Atonepoi.ng it was thought that the Sydney Futures Exchange and the ImndonInternational Financial Futures fichange -) M tidy si~~
agreements or were ready to do so. ‘fhe agreements with LIFFE were reported to have broken down because of a demand by CME for “exclusivity,”
i.e., that LIFFE not join other systems and not list contracts that would compete witi CME products. David BurtoQ Chairman of LIFFE, as quoted in
“Unraveling a Technology ‘lhngle,” Fuzures adoptions, special supplement to Euronwney, July 1, 1989.
~t,A~O~—EOS,J~ ~omotio~ literature distributed by ~OT.
~“Europe Forges Ahead in the Technology Race,” Fufures adoptions, Special Supplement to Eummoney, July 1, 1989, p. 2.
 Chapter 2--Information Technology for Global Markets ● 19

a.m. to 9 p.m. London time).26 NASD dealers will and experienced management at all levels around the
have a choice, on a security-by-security basis, of clock.
being a U.S. market-maker, a European market-
Although technology costs are declining relative
maker, or an international market-maker, and their
to capabilities and services offered, at the same time
workstation capability will be defined accordingly.
development costs, operational costs, and mainte-
All NASDAQ market services except for its auto-
nance costs of automation have risen. Automated
mated small order execution system (SOES) will be
systems rapidly become obsolete as new technolo-
available internationally. NASDAQ already shares
gies develop; they require sophisticated manage-
quotes with both the London and Singapore stock
ment information systems and technical infrastruc-
exchanges, for 700 and 35 cross-listed securities,
tures, with high re-engineering costs. Regulatory
respectively. Automatic intercontinental execution
rules often influence or even dictate technologies
and trade confirmation will now be possible over the
link. that must be used. These rules in many cases have
had a positive impact on the industry. For example,
NASD will also introduce, in 1990, an electronic The New York Stock Exchange’s rule number 387
system for global trading of unregistered (privately requires all member firms to confirm their trades
issued) foreign and domestic debt and equity securi- with institutional clients through the Depository
ties. The PORTAL27 system will allow users to dial Trust Co.’s automated Institutional Delivery system
up a special NASD host computer for both primary or its equivalent to be eligible for the delivery v.
and secondary market trading; participants will also payment function--i.e., to pay for securities only
be able to use their NASDAQ workstation for when actually received (by book entry) and not
secondary trading. All sales will be negotiated before. But other regulatory, legislative, and politi-
(investors will get quotations, last-sale price, and cal processes inhibit automation, including disputes
volume details on screen, in major currencies but over regulatory jurisdiction and foreign legislation
will work with a dealer). PORTAL will lock in prohibiting dissemination of some data. Resistance
transactions and allow settlement by electronic book to change, respect for tradition, and social customs—
entry through the International Securities Clearing which may reflect deeply rooted institutional rela-
Corp. [See figure 2-l.] tionships, strong economic interests, or cherished
values-also significantly impede automation in
TECHNOLOGICAL BARRIERS TO some foreign countries.
24-HOUR TRADING
Technology risks, such as communications out-
ages, are an important factor in 24-hour trading. Line
THE PROBLEM OF STANDARDS
outage and other contingency plans must be coordi- Electronic 24-hour/global trading has several
nated over several countries, different languages, problems yet to be solved. One is the issue of
staggered time zones and varying numbers of international regulation to control global market and
telephone companies. For example, to maintain a credit risk and to coordinate post-trade procedures.
dedicated circuit from New York to Tokyo can Another is the lack of global data standards.28 Two
involve from five to seven telecommunications levels of standards are important, those that affect
companies. This makes contingency plans difficult communication of data in general, and those that
to formulate. Global operations require competent particularly affect securities trading. The needs for

%ere will be two new kinds of market-makers on NASDAQ after this system opens-lhrqxan-ody market-makers from 4 a.m. to noon eastern
time and international market-mdcers from 4 a.m. to 4 p.rm, in addition to existing U. S.-or.dy market-makers. Market-makers will make the choice on
a security-by-security and ~-w-~1 “ 1 basis. NMD Executive Digest, Jtie 1989.
~~R~ s-s for ~v~e OHeringS, Resales, ~d TIWQ through Auto~ted L*ges.
nsmdsmgem~m~els, Speciticationsor criteriafortechnolog, designed to allow technologicdapplicationa coming ffomdiffe=tproduc~
to be ihteroperable. Interoperability allows users to mix and match components of, for example, communication systems and also makes it easier for
them to migrate to a new syst~ phasing out older equipment gradually. Standards may be set by custom or general consent, by market forces, or more
formally by authority. In the United States, standar~whenthey exist-are set by industry, often through professional associations. Standards-setting
in the United States is becoming more politiciz@ especially in communications standards, simx the Bell System no longer sets standards de facto. See
U.S. Congress, OTA, op. cit., footnote 1, pp. 297-299.
 Figure 2-1--Overview of International Trading Through NASD

Depositories
Custodial Banks

P m
International

J l

II ●

‘E E@EN
FAR
SYSTEM
Price Information and
International Order Flow
Local Firms

l t I

International Firms “Passing the Book” International Firms “Passing the Book” International Firms
Us. Europe Far East

SOURCE: National Association of Securities Dealers.

 Chapter 2--Information Technology for Global Markets ● 21

global standards range from technical standards and body must approve a proposed standard prior to
common languages to bank holidays.29 acceptance and promulgation). After a standard is
formulated, its adoption by member firms is still
International standards are becoming increasingly voluntary.
important for 24-hour trading; these problems are
not new to the general demands of international Technology standards are critical in terms of “the
commerce. The need for standards has arisen in weakest link. ’ That is, if the technical performance
many other fields, from railroad and air transporta- or capacity of a market participant, or clearing
tion to early telegraph, telephone, and most recently, member, is below those of the market or clearing-
computer-to-computer, facsimile, and digital voice house, then the benefit of the market’s or clearing-
communications. In each of these cases, countries house’s technology is compromised. There is no
developed their own systems, often independently of minimum standard required today for the technology
one another, often with little concern for future a broker or futures commission merchant must have,
international standardization or harmonization with either internationally or domestically, in order to
other countries’ systems. offer its clients the best access to price information
or to clearing services.
As needs for international commerce emerged,
countries typically moved to develop a set of Developing compatible standards for trading fi-
compatible international standards. This often led to nancial instruments is as important to international
establishing an international organization to facili- commerce as having the same gauge railroad tracks
tate or coordinate worldwide standards-making. in neighboring countries. The standards now being
Some of these, like the International Organization focused on by national and international bodies
for Standards (ISO), became permanent. The same eventually will provide the infrastructure for large-
pattern of evolution is happening today in the scale global trading. Until then, obstacles, risks, and
financial securities field. A half dozen international inefficiencies will remain in international trading.
bodies are currently studying some aspect of standards-
setting for international trading or regulation of Two types of standards 30 are important for both
these markets. domestic and international trading of securities, and
particularly for clearing, settlement, and payments
Standards that affect the financial trading indus- systems. The first type is technical standards, the
try, including markets, clearinghouses, brokerage second includes standards governing details of the
and banking industries, information service indus- process by which trading takes place and the
try, etc., are established in many different forums. infrastructure that supports trading.
The U.S. subgroup of ISO and the American
National Standards Institute set industrial standards Technical standards would include those that
for information processing and other technical apply to international communications in general—
subjects. The principal international bodies include e.g., international digital network standards for
ISO, which is the most influential; the Comite worldwide voice, data, and graphics services. His-
Consultatif International Telegraphique et Telephon torically, there have generally been two sets of
(CCITT); and recently several new international communications standards, the CCITT standards of
bodies, composed of representatives of the private the International Telecommunications Union fol-
sector and governments, have also been formed. lowed in most of the world, and U.S. standards that
Standards developed by these organizations are evolved more or less de facto through the dominance
formulated by consensus (75 percent of the IS0 of the Bell System in the United States.31 U.S.

%M&ringbankholidays is a serious problem; &cause, whenb~ are CIOSed securities transactions cannot be settled, and more importantly credit
cannot be provided for market participants, to assure continued liquidity. Consider the consequences if the October 1987 market crash had occurred 1
week earlier, on Columbus Day. U.S. exchanges were open but U.S. banks were closed, and critically important credit would not have been available
to bolster market liquidity.
~AMOU@ only tSVO Utegofies of standards are used here, other treatments might use four categories: process, risk assessment, tiastic-, ~d
procedures. Some of the examples cited in this section do not lend themselves to the adoption of uniform standards, but rather needed improvements
can be adected through harmonimtion. In some countries, for example, it is illegal to disclose or transmi t overseas information concerning a person’s
financial position. As another example, them are also problems in assessing risks that stem from different accounting practices in various countries.
slIthie~de SolapOOl, “Competition and Universal SeIViCe,” “mHany Shooshan (cd.), Disconnecting Bell, The Zmpact of the AT& TDivestiture (New
YOIIG NY: Pergamon Press, 1984), p. 119.
22 ● Trading Around the Clock: Global Securities Markets and Information Technology

equipment suppliers have increasingly had to adopt funds to protect customers of a failing broker or
standards set internationally, in order to compete in futures commission merchant, bankruptcy laws to
world markets.32 Two major sets of standards, for adjudicate the disposition of customer assets if a
ISDN and for open systems interconnection, are broker fails, credit processes at banks, clearinghouse
currently being debated in various international guarantees, etc.
meetings and consultations. With the planned inte-
gration of the European Community (EC) market in These standards govern the specific dimensions
1992 (ch. 4) there are even stronger reasons for U.S. of investor-protection regulation and fiscal responsi-
industry to coordinate its standards with those of the bility. Prospectus standards (disclosure of informa-
rest of the world. The EC established a European tion about a new issue), accounting standards, and
Telecommunications Standards Institute in 1988 for ownership standards35 are especially important in
standards development.33 A continuing industry- international trading.
wide effort is needed to coordinate U.S. standards Neither technical standardization nor harmoniza-
with evolving global standards. tion of regulations will come easily, cheaply, or
Some basic technical standards are essential for swiftly. Some markets will have to make costly
financial communications. One example is a univer- changes, while others will need more modest changes.
sal standard for international communications mes- Even modest changes can prove very difficult and
sage formats that facilitates instantaneous identifica- time-consumin g to implement because of the com-
tion of the exact details of a trading., the nation plexity of effecting change in established proce-
and firm originating the trade, the number of shares dures, and because any change can challenge vested
or contracts being traded, the price, and the identity interests.36 Some changes may be implemented by
of the transactors.34 Other examples include techni- the private sector alone, but others will require
cal details of how screen-based trading should occur government assistance, in the form of changes to
globally and the minimum level of technology to be regulation or legislation.
used by all participants.
Government involvement in standards-setting, in
Procedural standards are even more important. the United States, is controversial. There is a long
They apply to operational aspects of trading, clear- history of resistance to it from within the govern-
ing, and settlement; e.g., such as the method for trade ment as well as by industry. But business firms have
matching, number of days to settle a trade, use of a little experience, and in many cases little interest, in
depository for holding equities, use of a recognized protracted international negotiations. At a mini-
numbering system for identifying financial instru- mum, encouragement, facilitation, and leadership
ments and transactions, formats for data transmis- from government will be needed. More active
sion, the method of payment, etc. Infrastructure government participation in developing interna-
standards refer to the method of regulation, mecha- tional standards related to securities trading will
nisms to protect the clearinghouse against the probably be critical, because other governments are
financial failure of a clearing member, existence of deeply involved in the standards-making process.

3W.S. Congress, OTA, op. cit., footnote 1, pp. 295-300. For example, computer vendors andtelecommunication carriers had to adopt tie c~x.m
standard for electronic mail. Also, the Federsl Communications Commission has tried to speed up the U.S. standards-setting process for high definition
television because standards are being developed and adopted in other countries.
qqThis institute is f~nced by all of the European PTTs and major tekcommu.nications suppliers.
34T@y, ~ch com~ ~ i~ o~ syst~ for iden- trade dati informatio~ so there is little compatibility among tiese syst~ ~te~o~Y.
Recommendations have beenmade by the Group of Thirty to adoptISO standard 6166, which provides a uniform structure for the International Securities
Identification Number, and standard 7775, which deals with the uniform structure of securities messages, i.e., the message types. However, no country
has to date implemented either standard. Additional inter-depository/clearing system message standards are being developed.
sscom~es tier as to tie de~tion of a “share” and what rights are i.ncluded+.g., shareholder vo~g @@ts.
36~s ~ &n &e e=rieme of tie U.S. ~ Force of tie ~oup of ~, attemp~g to b@ about ch~e h cl- and settlement plVCeSXS,
as discussed inch. 5, according to OTA staff discussions with Gerard Lync& a Managing Director at Morgan Stanley, Inc. and head of the U.S. Working
Group of the Group of Thhty, December 1989.
 Chapter 3
The Extent of International Securities Trading

Global trading of securities is rapidly develop- markets, and it is not yet certain that their relative
ing.l The foreign exchange (currency) and govern- immunity to Japan’s problems will last.
ment bond markets are already thoroughly interna-
tionalized. Most international securities trading now The globalization of securities markets raises an
involves debt securities rather than equities. To what important question for U.S. policymakers: What
extent this globalization will also apply to corporate actions need be taken to assure the position of the
equities, and how quickly, is somewhat uncertain, United States as a world center for securities trading
but by most measures it is well underway. There is and other financial services? The claim is often made
already growing cross-border trade in the shares of that U.S. markets are the best in the world in terms
many giant multinational companies. Most ex- of liquidity, efficiency, and fairness, but they have
changes have opened their membership to foreign- increasingly strong competition. In 1980 the United
ers. Some exchanges are already offering derivative States accounted for 55 percent of world stock
products (e.g., stock-index futures contracts) based market capitalization, but that stood at 35 percent in
on stocks that are listed and traded in the markets of 1990, having dropped for a time to a low of 32
a different nation. percent 3 (see figure 3-2). The Tokyo Stock Ex-
change was the world’s largest from 1987 to 1989,
but then fell back to 34 percent in 1990 as a result of
Securities markets are already globally linked in large declines in market prices. Japan’s first rank in
still another sense. Because of the growing interde- 1987 to 1989 raised fears in some quarters that the
pendence of national economies around the world, United States is falling behind in global securities
their securities markets tend to move in parallel, trading. Market capitalization alone is not a good
especially in times of stress.2 This parallel move- measure of market strength, or of trading perform-
ment was illustrated in the crash of October 19-20, ance; it is affected by many other economic condi-
1987, and again on October 13, 1989, when markets tions. 4 But rightly or wrongly, the performance and
around the world saw a sharp decline (figure 3-l). In vigor of securities markets is often taken as an
the first 3 months of 1990, when the Japanese Nikkei indicator of the health of an economy, and thus has
Index lost about 25 percent of its value in a series of significant political implications.
spasmodic declines, it was widely feared that other
markets would also drop. This did not happen, Additional risk to U.S. investors is also a public
apparently because there were specific domestic policy concern. As the globalization of securities
reasons for the Japanese market’s behavior, but there markets continues, Congress will need to address
were definite ripple effects in U.S. and European several questions:

lm chapter draws on amend OTA contractor reports, including: tic K. Clemens, Principal Investigator, witi St.epk p. BroW ~vi
%nkateswaran, and Bruce W. Weber, “Globalization of Securities Markets”(Philadelph@ PA: Wharton School, University of Peansylvar@ July
1989); Peter Schwar@ “Scenarios for Regulation of International Securities Trading” (San Francisco, CA: Global Business Network Nov. 3, 1990);
Manning Gilbert Warren III, “Securities Regulation in the European Communities” (Tuscaloo~ AL: University of Alabama Law Schoo~ August
1989); KPMG Peat hfarwic~ “The Competitive Position of Commercial B-in the Global Securities Markets: An International Study,” 1989.
~or example, in most markets equity prices rose from August 1982 until September 1987. During the 6-day trading period from the end of Oct. 9
through Oct. 19,1987 (Oct. 20 for Japan), the Dow Jones Industrial Average declined by 30 perce@ the NASDAQ Composite Index by 18 perce@ the
ISE Financial Times 100 Index by 13 percent and the l’b~o Stock Exchange Nikkei 225 Index by 17 percent. NASD Special Committee of the
Regulatory Review ‘I&&Force, “Quality of Markets,” p. 17. See also, Federal Reserve Bank of New YoI& “The International l%msnus“ sionof Stock”
GeorgeM. vonFurstenberg and Bang NamJeo~ “International Stock Price Movements: Links and M~gw,’’BrootingsPapers onEconom”cActivity,
No. 1 (Wash@to@ DC: Brookings IrIstitutiom 1989), p. 165; and “Price Disruption in October 1987,” and “InternationalLink ages Among Equities
Markets,” QuurterZy Review, vol. 13, No. 2, Summer 1988.
%tal world capitalization was about $9.4 trillion. Japanese share of world capitalimtiodrose from 17 percent in 1980 to 45 percent in 1989. Data
suppli&l to OTA by International Finance Corp. and the New York Stock Exchange. Figures for the end of 1988 were even more striking: world total
capitalhtion was $9 trillion, United States 30 perccn~ Japan 42 percent. The 1990 figure for Japan is from the Finuna”al Times, March 1990, p. 40.
%the 1980s the United States had arecessio~ and the value of the currency few which affected the rate of capitalization. Japanese markets expanded
because of the success of Japanese industry, Japan’s capital surplus, its high savings rate, and the Japanese Government’s use of the stock market as an
instrument of economic policy in privatizing government-owned industry and restructuring financial services. Three national companies have been
privatized: Japan Tbbacco, Japan National Railways, Nippon Telephone& Telegraph.

–23-
24 ● Trading Around the Clock: Global securities Markets and Information Technology

Figure 3-l—Evidence of the World’s Markets on Oct. 13,1989

Bangkok: down 6% Toronto: up 1.46% London: down 3.2%

Hong Kong: down 6.5% New York: up 3.43% Paris: down 5.4%

Taipei: down 3.3% Oslo: down 11.3%

I Ill
Seoul: down 0.7% Frankfurt: down 12.8%

Tokyo: down 1.8%

I I

I
Wellington: down 8.5%
I
Sydney: down 8%
11 I Athens: down 10.05%

Manila: down 5.92% I Zurich: down 10.2%

Madrid: down 5.3%
Singapore: down 10%
Kuala Lumpur: down 11.5% Lisbon: down 7.6%

SOURCE: Washington Post, Oct.17, 1989.

What additional risks to U.S. financial systems ment across national boundaries are serious prob-
might result? How can unacceptable risks be lems: “It is the float that creates systemic risk.”5 He
avoided? called for harmonization of national regulations and
Will U.S. investors be adequately protected in standards to eliminate artificial reasons to favor one
global investing? market over others.
How can the United States encourage the
development of worldwide cooperative or reg- These risks may grow worse as globalization
ulatory mechanisms for trading in international continues. Grant L. Reuben, an international bank-
securities? ing expert, warns, ‘‘. . the enormous volume and
Alan Greenspan, Chairman of the Board of speed of transactions and the cross-border integra-
Governors of the Federal Reserve System, recently tion and interdependence of institutions and markets
told a congressional committee that the delays and have magnified both the impact and speed that a
uncertainties of trade execution, clearing, and settle- problem in one national market has on others.”6

5 0 A te~~ony on J~= 14, 1989, ~ H~g~ on ~te~tio@~tion of sec~ties ~~, before tie Subcommittee on kld.kS, SCMte
Committee on Banking, Housing, and Urban Affairs. Systemic risk is a condition that threatens the stability of the nationalfmcial system or payments
systerrq for example, the catastrophic failure of a major f~cial institution accompanied by cascading failures as the institutions on the opposite side
of that institution’s transactions in turn are unable to meet their obligations, causing their own creditors to be unable to pay still others, etc.
%mnt L. Reubeu Deputy Chairma n of the Bank of Montreal, ‘‘Implications of Globalization for Regulation and Safety,’ remarks at the Financial
Globalization Conference, Chicago, IL, Nov. 2, 1989.
 Chapter 3-The Extent of International Securities Trading ● 25

Figure 3-2—Market Capitalization of World’s Stock Markets

8000
Market value of total shares (billion U.S.$)
~
1 A
Switzerland
~ France
A--- Canada*
West Germany

United Kingdom

5000
$ A

4000
Japan**

3000
A
i

United States***
1000

0
1978 1980 1982 1984 1986 1988

Toronto Stock Exchange

● TSE only
● **NYSE
SOURCE: Internationalization of the Securities Markets 1988. Federation of German Stock Exchanges Annual Report, 1988.

TRENDS DRIVING ● increasing world trade and interdependence

among national economies;
GLOBALIZATION
● concentration of capital in countries with rela-
Institutional investors, and to a lesser degree tively limited opportunities for domestic in-
individual investors, trade in the markets of more vestment, especially Japan;
than one country in order to find higher rates of ● the necessity in some countries, especially the
return at acceptable risk, to diversify their portfolios, United States, of financing government debt
or to take advantage of other hedging techniques. (this led the United States, for example, to
The forces encouraging the rapid expansion of encourage foreign trade in Treasury bonds);
international securities trading are: ● the growth of large institutional funds such as
mutual funds and private and government
. the declining costs of international communica- pension plans, with a need to diversify their
tions; investments and hedge their risks;
26 ● Trading Around the Clock: Global securities Markets and Information Technology

the changes in regulation of financial services countries, but they need to raise capital in the local
in many countries, opening their markets to currency for plant, property, equipment, and daily
foreign participants; and operating expenses. International trading of corpo-
the increase in international public offerings, rate securities grew sharply in the 1970s and 1980s.
especially as a result of privatization of government- After the 1987 market crash, there was a temporary
owned industries in several countries. reduction in international trading. Most agree that
international trading incorporate equities is likely to
Communications be limited to stocks of “world class” corporations.
The growing availability of telecommunications There are already at least 500 corporations whose
and computers reinforces the effects of these trends. issues trade internationally.
Not only is information technology necessary for It is possible that a two-tier market will develop,
global trading of securities; it stimulates all kinds of with trading in these securities conducted in one to
trade among nations, familiarizingg potential inves- three world markets, with participants passing their
tors with many translational corporations and their trading books from London to New York to Tokyo,
products and services. This reduces one historical while other securities are traded only in their local
barrier to trading of corporate securities outside of market or time zone. The implications of such a
their home market-the lack of knowledge about two-tier market are uncertain. Already European
underlying values on the part of foreign investors. securities market planners and developers are debat-
Telecommunications brings increased access to ing whether there should be different systems,
economic, industrial, political, and social informa- different procedures, and different rules for retail
tion, both through the public media and through customers and international/professional traders.8 In
specialized information services. This is not an the United States, the Securities and Exchange
unmixed benefit. The speed with which information Commission (SEC) has approved a new rule (144a,
is transmitted between markets can have an adverse Apr. 19, 1990) that will allow institutional investors
effect, if it forces decisionmaking at apace too rapid greater freedom in trading private placement securi-
for the exercise of discretion. Communication of ties by exempting many such securities from regis-
trade data is, moreover, not sufficient for disclosure tration requirements if they are not available to
of risk in securities trading. Basic data on many individual investors.
European, Asian, and South American corporations
are not available, and there is little trans-border Capital Imbalances
financial research and analysis available to investors.
Another force driving the globalization of securi-
In the early morning of October 19, 1987, hours ties trading is that some countries have accumulated
before the New York markets opened, U.S. portfolio ‘‘excess capital’ not matched by productive domes-
managers who anticipated a sharp drop in value of tic investment opportunities. That money is availa-
equities tier the previous week’s slide, began ble for investment through the securities markets of
selling shares in London. One mutual fund was said other countries. One example is Japan, with its high
to have unloaded $95 million of equities, 7 illustrat- volume of exports. European investors also find that
ing the ease with which both information and capital their domestic markets cannot meet their investment
can flow across national boundaries. demands. 9
International imbalances lead to a flow of capital
Interdependence
across national boundaries that some economists
World trade patterns in goods and services view with concern. In the United States, the growing
encourage world trade in securities. Not only do Federal deficit has been financed to a significant
multinational corporations become familiar in many degree by foreign purchases of Treasury bonds.

bMelam~ “ThePainful Tru@” The InternationalEconomy, July/August 1988, p. 59. MelamedChamnan is “ of the Executive COmmittee of
the Chicago Mercantile Exchange, This figure was put at $90 million in the Report of the Presidential Thak Force on Market Mechanisms (The Brady
Commission), January 1988, p. 30. Some O’lA informants and advisors believe it was much larger.
%YIX disc~sions with oflkials of the International Stock Exchange inIxmdoQ March 1990.
%oy C. Smi@ “International Stock Market Transactions,” NewYork’ sFinanciuZiUarkets: The Chdenge of Globalization, Thierry Noyelle (cd.)
(Boulder, CO: Westview Ikess, 1989), p. 8.
 Chapter 3--The Extent of International Securities Trading ● 27

There is concern that we have become dependent on Figure 3-3-Foreign Holdings of U.S. Financial Assets
an inflow of foreign capital that could be cut off, or
Billions of dollars
could undergo sharp price increases (see figure 3-3). 1400
But U.S. policy with regard to international securi- 1213.9
1200
ties trading has been that the unimpeded flow of i 1074.9
capital funds across national boundaries is basically 1000
advantageous both to countries requiring additional
capital funds and those seeking markets for surplus 800
capital funds.10 Consequently the United States has 600
placed few restrictions on foreign portfolio invest-
ment, and those are chiefly for information- 400
gathering. 11 SEC disclosure rules, for example,
200
apply to foreign as well as domestic issuers, and this
is a problem for some companies whose home 0
1980 1981 1982 1983 1984 1985 1986 1987 1988
countries do not have similar requirements.
SOURCE: Goldman Sachs Portfolio Strategies, December 1988.
Financing National Debt
Foreign investment in the United States was percent of foreign activity in U.S. securities was in
essential to economic development in our first corporate equities, but this has fallen steadily, to 9
hundred years. In the middle of the 19th century percent in the first half of 1989, as U.S. Government
foreigners held about half of Federal and State debt debt became the focus of foreign investment; the
and a quarter of municipal debt. During the next six proportion of foreign activity in Treasury bonds rose
decades foreigners invested heavily in such bur- from 53 to 87 percent. 14
geoning American industries as steel and railroads.
Only during World War I did the United States cease Institutional Investors
being a debtor nation for a few decades as European
The growth of institutional investment funds such
nations liquidated U.S. holdings to raise money for
as pension funds and insurance funds, especially in
the war.12
the United States, is a major force encouraging
Further growth of the U.S. deficit and uncertainty international securities trading.15 Public and private
about the stability of the dollar could inhibit foreign pension plans represent large concentrations of
investment. It has probably caused some shift in funds that must be invested, and’ many institutional
Japanese equity investments from the United States investment managers want to diversify fund hold-
to Canada, Europe, and Australia.13 In 1980, 41 ings outside of their own country to protect against

loJ~u5w.Allem “CapitdNWket Changes inthe United Kingdo~ JSPSXL West ~, and Singapore, A Brief Survey,” Congressional Research
Service Report 88-49-E, Jan. 14, 1988, p. 2.
ll~eme some limitations on direct foreign investment in specific industries such as energy, maritime, _COm.m~~tiOnS, @b_. ~
International Investment Survey Act of 1976 (22 U.S.C. 3101 et seq.) mandated a study of the extent of foreign investment to be performed every 5
years, and the Domestic and Foreign Investment Improved Disclosure Act (part of the Foreign Corrupt Practices Act of 1977, Public Law 95-213)
~ed ~Yone a~uirins 5 percent of the equity securities of an SEC-registered company to disclose ci”tuxmship and residence. MichaelSeitzinger,
Foreign Investment in the United States: iUajor Fe&ral Restrictions, Congressional Research Service Report 88-164 A, Feb. 23, 1988.
l?l’bid. rn 1988, total foreign direct investment inU.S, plants and machinery was $326.9 billiou compared to U.S. d~t ov~ investment of $308
billion. But the U.S. investment is oldeq its current value is probably much higher. Some experts say tbat the returns on foreign investment here are
significantly lower than returns on U.S. investment overseas. See, for example, Stephen Kindel, “Return of the Native,” Finana”aZ WorZd, Jan. 9, 1990,
p. 20.
13111E U.S. share of these Japanese institutional invesbrmts droppedfkom 55 percent in 1986 to 51 percent in 1987, according to Yasuhko
“ u-
“Japanese Imumnce Companies: Our Strategy for Irtvesting in Ameriw” The International Economy, July/August 1988, pp. 64-65. Mr. Ueyama is
president of Sumitomo Life Insurance Co. These figures were confiied by the International Securities Clearing Corp. in 1990, but more recent figures
are not available.
14s~tia ~m~ A5m~tioQ C’Foreign ~tivi~ Repofi$’ JSIL 25, 1989, p. 5 and update by telephone, Novembes 1989. Foreign activi~ in
corporate bnds dropped fkom 5.3 to 2.6 percent during the period 1980-88.
ls~d ominanceof institutional traders differs to someextentbycountry. InEurope, thelargestholders of equities srebiginstitutiona, andlsrgebanks
usually handle investments for individual investors in a discretionary mode.InJap~ 69 percent of equities are held by corporations or institutions, but
these tend not to be traded. Individuals do about 42 percent of the securities trading.
28 ● Trading Around the Clock: Global Securities Markets and Information Technology

both potentially adverse currency

16
fluctuations and (sometimes misleadingly called “re-regulation”),
domestic economic recessions. The value of cross- aimed at stronger investor protection. London’s
border portfolio investments by U.S. private-sector dramatic access deregulation in 1986, called “Big
pension plans grew from $21 billion in 1980 to $225 Bang,’ stimulated other European exchanges to
17
billion by the end of 1988. improve their quotation and settlement systems,
broaden exchange membership, and lengthen trad-
Some doubts about the value of this diversifica- ing days.
tion as a kind of transnational hedging have emerged
because of the way markets behaved in October
1987. As described in The Economist: Privatization
. . . the world’s 23 largest stock markets fell together Another force encouraging the cross-national
during the October crash; and . . . most of them holding of equities has been the privatization in the
tracked each other closely for months. The correla- United Kingdom and Japan of-very large industries
tions between stock markets during and after the that had been owned by the state. More stock had to
crash were uncanny and unprecedented.18 be offered for sale than could be absorbed by
investors in a single country, so there have been
This lessens the protection against risk to be
many stock issues that are offered in several
achieved by international diversification. The corre-
countries at the same time, with each country’s
lation in market behavior is to some extent inevita-
allotment, or “tranche,” consisting of millions of
ble, given the interactions between interest rates and
shares.
currencies, although precipitous drops in Tokyo
stock prices in the first quarter of 1990 had only
slight immediate effect on other markets. Because of OBSTACLES TO INTERNATIONAL
the swift flow of information and the ease of shifting SECURITIES TRADING
investments from one market to another, a precipi-
tous decline in one marketplace could at any time Although there are strong forces encouraging
alarm investors in other marketplaces and cause globalization, there are also many obstacles:19
them to react. But international diversification also lack of liquidity in smaller markets;
has other benefits, and is likely to remain attractive government policies or regulations designed to
to institutional investors. exclude foreign participants from national mar-
kets;
other legal barriers such as exchange controls,
Regulation and Deregulation
discriminatory taxes, and deposit requirements;
Deregulation in the United Kingdom, Japan, and differences at the interface of banking and
France has also encouraged international trading by securities activities;
increasing the access of foreigners to those national difference in clearing, settlement, and payment
markets and their securities firms. This kind of systems;
deregulation may be called “access deregulation.” nongovernmental but officially condoned prac-
There has been a general worldwide trend toward tices (in effect, non-tariff trade barriers) which
access deregulation, and at the same time a world- exclude foreign interests, such as restrictions
wide trend toward increased prudential regulation on membership in exchanges;

IGFrom 1985 to 1987, U.S. Wmion plans increased their foreign equity holdings by $19 billio~ while their holdings of U.S. Witks d-m~ by
$47 billion. SmitlL op. cit., footnote 9. At the end of 1988, U.S. private-sector pension funds had $52,5 billion in foreign investment. United Kingdom
private pension plan investment overseas was $69 billion at the end of 1988, Japanese private pension plan investment overseas was $33 billion. Foreign
private-sector pension plans hadapproximately $62.4 billion in portfolio investments intheUnited States at the end of 1988, and this hadgrownto $67.7
billion by June 1989. (Information provided by Intemec Research Corp., November 1989.)
ITFi~s for 1980 ~d 1987 ~m SEC SW Report to U.S. Semte comrnitt~ on B-g, Housing, and Urbm A.ffti Ud U.S. HOW Of
Representatives Committee on Energy and Commerce, “Internationalization of Securities Markets,” 1987, p. 88; 1988 figure provided by Intemec
Research Corp. to OTA, November 1989.
lsBy~ne set of me-ements, the ~~e~tion~W~nthe23 biggest stoc~kets, whichw~ ().222 for more ti5 ye~ before ti Cr~ W= ().’755
at the time of the-crash and has since then remained about 50 percent higher than the pre-crash figure. “Why Stockmarkets Move Together,” The
Economist, Mar. 11, 1989, p. 77.
lgf$~~~o~ T~de in Services: fkXllrkies,” summary of a report by the OECD Committee on Financial Markets, in OECD, Finuncia2 Market
Trenak, May 1987, pp. 15-43.
 Chapter 3—The Extent of International Securities Trading ● 29

● differences as to accounting practices, regula- Federal Reserve Board-have gradually relaxed the
tory structures, capital adequacy requirements, interpretation of the Glass-Steagall Act to allow
and investor protection standards; banks and bank-holding companies to edge into
. differences in corporate organization; and some securities-related activities.
. other social, cultural, or behavioral barriers.
HOW “GLOBALIZED” ARE
The risks imposed by these difficulties, and
particularly by the lack of standardized or harmo- SECURITIES MARKETS?
nized methods of trading, clearing, settling, and Several kinds of activities are subsumed in
making payment are serious. Many international ‘‘market globalization,’ a term that is often loosely
trades fail to settle on time, often because as many used. They are:
as 12 financial institutions maybe intermediaries to
a single securities transaction.20 (See ch. 5.) ● cross-listing stocks and bonds issued in Coun-
try A on the exchanges of Country B;
Laws and regulations in some countries forbid ● investors of one country buying and selling
various kinds of participation in securities markets foreign stocks in foreign markets, through
by foreigners. Tax laws may also inhibit foreign foreign brokers;
activities or reduce their profitability. Activities that ● opening a country’s stock markets to foreign
are permissible in one country are illegal in others. brokers and dealers who serve both foreigners
Less formal but pervasive social and cultural and nationals;
differences are also important. Outsiders may not be ● legal or contractual ties between exchanges in
able to operate efficiently because of ignorance of different countries;
language or culture or lack of necessary professional ● “passing the book” or 24-hour trading, i.e.,
contacts. They may find it hard to recruit and shifting the control of trading to colleagues in
manage indigenous staff. Access to bank loans may other countries and time zones;
be difficult. In Japan, for example, long-established, ● multinational offerings of stock;
interlocking, and stable relationships between do- ● international mutual funds; and
mestic companies and banks put foreign firms at a ● cross-national stock index derivative instru-
competitive disadvantage. ments.

One important difference between national secu- Cross-listing of Stock

rities markets is the extent to which banks are
A simple form of internationalization of markets
allowed to participate. In the United States, the
is listing stocks issued in Country A on exchanges in
Glass-Steagall Act of 1933 separated banking and
Country B. The value of cross-border offerings of
securities-related activities. Japan’s Article 65 is
bonds, including foreign and Eurobonds, grew from
modeled after the Glass-Steagall Act. Until recently,
Canada also placed legal barriers between banks and $38 billion in 1980 to $238 billion in 1988. The
value of cross-border offerings of equity-related
most securities markets activities. Most other coun-
securities grew from $200 million in 1983 to $20.3
tries have ‘universal banking,” meaning that banks
billion in 1987.22
can do underwriting and otherwise participate fully
in securities markets, and banks are often the London’s International Stock Exchange (ISE) is
dominant participants in those markets. The general the most “internationalized” of the world’s big
international trend has been toward more homogene- exchanges, with 23 percent of the companies whose
ous regulatory treatment of financial institutions stock is listed on the ISE being foreign companies.
within countries.21 This is true even in the United The Tokyo and New York Stock Exchanges, which
States, as Federal regulatory authorities--the Comp- are larger markets, have far fewer foreign companies
troller-General (Department of the Treasury) and the listed (table 3-l); in 1989, the NYSE listed 82

~Jllni~W.P~e, “ACasefor StandardS inIntemational Financial Markets-Jan. 1, 2000,” a discussion paperpmp~edfor tie~~~ Mee@
of the International Organization of Securities Commissions, Sept. 1-4, 1987, Rio de Janeiro, Brazil.
21~MG pa -C. ~~~ Coqetitive ~Sition of c~erc~ B* ~ tie Glo~ S-ties -J@s: AII kte~tio~ S~dy,” COXItrtiCtOr
report prepared for the Office of Technology Assessment January 1990.
~s~ op. cit., footnote 14, PP. 58-59.
30 ● Trading Around the Clock: Global Securities Markets and Information Technology

Table 3-l-Comparison of Major Markets

Tokyo Stock New York London Stock
Exchange Stock Exchange NASDAQ Exchange (lSE)
Annual average trading volume
[$ billion] . . . . . . . . . . . . . . . . . . . . . $2,234 &1 ,356 $ 347 $ 361
No. of listed companies, 1988 1,683 1,681 4,451 2,580
—Domestic . . . . . . . . . . . . . . . . . . 1,571 1,604 4,179 1,993
—Foreign . . . . . . . . . . . . . . . . . . . . 112 77 272 587
% Foreign . . . . . . . . . . . . . . . . . . . . 6.7% 4.6% 6.1% 22.7%
SOURCE: Office of Technology Assessment, 1990.

foreign stocks or ADRs23--3.7 percent of its list- nies. Corporations are attracted by the large amount
ings. In the frost quarter of 1990, this rose to 93 of capital available for investment and by the belief
listings, and their trading accounted for 5.8 percent that Japanese investors are more interested in
of total share volume.24 NASDAQ includes 196 long-term growth and less concerned with very
foreign issues and 96 ADRs, 5.7 percent of listings. short-term performance than are U.S. investors.
Some multinational corporations also reason that
Several smaller markets, particularly in Europe, listing in Japan improves their corporate image in
are more “international” Of stocks listed on the that country, helping them to attract a Japanese work
The Netherlands exchange, 56 percent are non- force. Obtaining a listing on the TSE is, however,
-domestic; Germany, 49 percent; Switzerland, 42 complicated and costly.
percent; and France, 32 percent.
In the United States, foreign firms who want to list
Most stocks are still traded only in their country their securities on a U.S. exchange or NASDAQ may
of origin. But London’s SEAQ International regu- register them with the Securities and Exchange
larly quotes 750 foreign equities, with continuous Commission (SEC), thereby subjecting themselves
quotes in about 350 of them, resulting in trades to our reporting provisions.27 The SEC has, as noted,
valued at about £ 1 billion daily, compared to £ 1.4 recently approved a rule exempting from reporting
billion in domestic equity trades and £ 10 billion in requirements companies offering private issues only
bonds. 25 In Tokyo about 120 foreign issues are to large institutional investors.28
traded, generally less than 2 percent of total volume,
but recently this has risen to about 7 percent. International Portfolios
Euromoney magazine reported in mid-1988 that
there were 487 stocks with an active and liquid Another measure of internationalization is cross-
market in at least one trading center outside of its national portfolio investment, the degree to which
home Country.26 The home country, for 60 percent of Country A’s investors buy stocks issued in Country
these stocks, was either the United States, Japan, the B. For all countries, investment in non-domestic
United Kingdom, Australia, or Canada. securities was $250 billion in 1984 and $1,281
billion in 1987, a fivefold increase in 3 years (table
Obtaining a listing on the Tokyo Stock Exchange 3-2). This strong growth in cross-national invest-
(TSE) has become an important element in the ment inequities was reversed temporarily in 1988 as
global strategy of many export-oriented U.S. compa- an aftermath of the 1987 crash. New foreign

~Non.u,s. corporations Wishg to bve their equities securities traded in the United States can choose to hWe them lmkd w acti~ Sws or m
AmericanDepository Reeeipts (ADRs). AnADR is a receipt issued by aU.S. b@ conversable into a specified number of shares deposited in the issuing
eoqmration’s country of domicile. An ADR may be freely traded in the ADR marke~ related to but distinct from the market in the actual shares. Should
a U.S. holder wish to obtain the shares, the ADR is presented to the U.S. depository bank for cancellation and reregistration before the original shares
ean be delivered to the holder. Price information on an ADR is in U.S. dollam and maybe easier to get than the price of underlying shares; purchasem
of ADRs pay domestic rather tban foreign trading commissions.
~~o~on supplied by the NYSE Washington office, Apr. 2, 1990.
nS~Q kte~tio~ statistics.
~Euro~n~, Iv@ 19*8.
~But not t. some o~r ties, such ~ ~= gove~g ~eholder proxy votes. Regist~g is optio~ ~ess me foreign issuer @ mOre dUll 3~
record shareholders in the United States, more than $3 million in total assets, and is engaged in business affecting interstate commerce.
~R~e 144A, approved Apr. 19, 1990.
 Chapter 3--The Extent of International Securities Trading ● 31

Table 3-2—Total Cross-National Investment

Box 3-A—Exogenous Events and
Total U.S. Markets
Year (billions of dollars) Change
1984 . . . . . . . . . . . . . . . . . . . . . . . $250 – U.S. markets could be thoroughly shaken by
1985 . . . . . . . . . . . . . . . . . . . . . . . $400 +60% seemingly unrelated events in far-away places.
1986 . . . . . . . . . . . . . . . . . . . . . . . $750 +88% Noting that some seismologists are predicting
1987 . . . . . . . . . . . . . . . . . . . . . . . $1281 +71% possibly devastating earthquakes in the vicinity of
1988 . . . . . . . . . . . . . . . . . . . . . . . $1031 -19.5%
Tokyo, Tokai Bank generated the following sce-
SOURCE: Securities Industries Association. Global Equity Analysis Re- nario:
ports.
. . . Tokai Bank has estimated the damage that
would be caused to financial markets if there were
investment in Japanese, American, British, Cana-
a repeat of the 1923 earthquake, a 7.8 on the Richter
dian, and West German equities in 1988 dropped scale, that reduced Tokyo to rubble and left 142,000
much more than did domestic trading in those people dead. The bank’s conclusion is that Amer-
stocks. 29 In the highly internationalized London ica’s stock and bond markets would be reduced to
market, foreign trading in U.K. equities dropped rubble too.
nearly 30 percent, while all trading in U.K. equities . . . (W)ith one-third of Tokyo’s reclaimed land
dropped less than 5 percent.30 Only Japanese inves- liquefying into mud, reconstruction would cost
tors made more overseas equity trades in 1988 than Y119 trillion ($847 billion). Japanese institutions
in 1987. Although reduced, the 1988 cross-border would have to sell investments in America, sending
stock and bond prices tumbling and interest rates
equities trading was still above that of 1986 and over soaring worldwide. Side-effects would be global
three times the amount in 1984. stagflation and a worsening of the Third-World debt
problem.
In 1950, foreign investors held a little more than
2 percent of U.S. securities; in mid-1988 it was The hypothetical earthquake that the bank sent
nearly 12 percent.31 Foreign investors hold nearly 22 rumbling through its computer model knocked 4.8
percent off Japan’s gross national product for the
percent of U.S. Treasuries (however, the holdings of current calendar year, causing the world economy to
corporate bonds increased faster than holdings of shrink 0.3 percentage points in 1989. The economic
Treasuries). Foreign investors held about 6 percent effects would go on reverberating for years . . . .
of U.S. equities in mid-1988.
SOURCE: The Economist, July 15,1989, p. 7. (Condensed)
The large growth of foreign portfolio investment
in the United States could be risky in a way that
direct investment is not. Multinational firms monitor
their currency exposure and stand ready to make On the other hand, a strong case can be made that
massive shifts in response to changing conditions. foreign capital, especially Japanese capital,. has
Factories or farmlands will not be moved outside of acted effectively to stabilize American financial
the country, but foreign capital can be withdrawn in markets in recent years. David Hale, an international
a matter of minutes or hours. 32 This could amplify a economist, says,
market decline, turning it into a rout. [See box 3-A.]
In February 1990, as the Tokyo Stock Market went In 1987 and 1988, the Bank of Japan purchased
into a several-day decline for the frost time in years, over $55 billion of U.S. securities in order to
this concern was voiced by a number of financial stabilize the dollar. The Ministry of Finance often
experts. used moral jawboning to prevent Japanese institu-

=oreign individuals and institutions made purchases and sales of $288.3 billion iu all U.S. securities msrkets in the firat 9 months of 1988, which
was doti 19.8 percent from the firat 9 months of 1987. AU transactions in foreign equities made on U.S. markets were also down in the same three
-s by 24.3 percenti to $107.3 billion.
~S~ties~d~~es ~=i~oQ G[o~[E~’~A~ly~sRepo~, vol. ~, Noe 5, J~y 7, 1$)8$). Japanese illVtXtOIS’ nOtpllNhSSSS Of fOre@l Securitk?
in 1980 was $4 billiou in 1988 it was $87 billio~ and in the fust 7 months of 1989 it was already $55.3 billion.
31Jefi~ ~. &.~efm ~ David G. Strom “my ~ the ~s About Fore@ ~ves~@” C)@/enge, ~y-Jme 1989, pp. 31-35. F- S1’e
baaed on Federal Reserve Flow of Funds, U.S. ‘Ihsury.
WnecommentatorW eges thatJapanesefund managers “triggeredthecrash”(~ 198’7) @[email protected]. ~“es 5 days earlier, causing a collapse
in bond prices and a resulting rise in interest rates thatled to widespread selling of equities. R._ Murphey, “Power Without Purpow: ~ ~~
of Japan’s Global Financial Dominance,” Harvard Business Review, March-April 1989. But this report is not widely accepted.
32 ● Trading Around the Clock: Global securities Markets and Information Technology

tional investors, from dumping dollar securities staff, and anew headquarters. Merrill Lynch became
during periods of exchange rate uncertainty. 33 the second largest Eurobond underwriter, and by
1987 it had a staff of 1,600 in London.37 Other major
Richard Koo of the Nomura Research Institute told
U.S. securities firms and banks also made major
the Joint Economic Committee of Congress,
efforts to build business in London. But after the
During 1986 and 1987 . . . when the dollar and October 1987 crash, they sharply reduced their
financial markets around the world came precari- London staff. All foreign brokerage houses in
ously close to total collapse, Japanese authorities London were reported to be losing money in 1988
tried to keep investors in dollars by telling them how
and 1989. The unprofitability of such foreign
much good the U.S. had done for Japan after the war,
ventures causes some observers to doubt that inter-
and how important it was for Japan to stay with the
dollar to prevent the total collapse of the world national securities trading will grow as much, or as
financial system.34 rapidly, as enthusiasts had predicted. But a more
likely outcome is that as international trade in-
Opening National Exchanges creases, a few very large securities firms will
eventually dominate the field.
Cross-country exchange membership and broker-
age is another form of internationalization. Many
countries have opened their exchanges for member- Passing the Book
ship by foreign firms within the last 5 years, or have
allowed foreign firms to buy or buy into their Twenty-four-hour trading is what many think of
domestic securities houses for the first time. For as “globalization.” This occurs when a firm has
example, the first 6 foreign members were allowed facilities in locations around the world, and passes
to join the Tokyo Stock Exchange in February 1986, its “book” (i.e., control of its active trading)
and in 1988 16 more seats were made available to between those locations across time zones, in order
non-Japanese firms.35 Other foreign firms probably to trade some instrument such as U.S. Treasury
want seats, even though membership costs are high. bonds around the clock.38 (See figure 3-4.) Most
There are at least 47 foreign securities houses with 24-hour trading now is in foreign exchange and
branches in Japan; most were reported to be losing bullion, not equities.
money in 1988-89. Four large Japanese firms trade
There is some skepticism as to how prevalent
overseas (Nomura, Daiwa, Nikko, and Yamaichi),
24-hour trading in equities will become. One study
and are reported to have invested $350 million in
called 24-hour trading a myth, and said,
building up their American businesses. These are
very large fins, so their international business Many of those who profess to trade for 24-hours
accounted for only 1 percent of their pre-tax profits acknowledge that they do so to maintain a “global”
in 1987-88, down from 5 percent the previous year.36 profile, not because 24-hour trading is a prime goal
in itself.39
Many American stockbrokers sought to operate in
London’s markets after the 1986 deregulation. Other skeptics, attuned to the traditional, face-to-
Merrill Lynch, the first U.S. firm with an affiliate on face form of trading prevalent in New York and
the London Exchange and among the frost to apply Chicago, say that trading is an intensely personal
for a primary dealership in government bonds, spent activity and traders will neither be able to stay awake
many millions of dollars in London on computers, 24 hours or to let someone else trade for them. This

33David D. H~e, “The J~~ese h4inistry of Finance and Dollar Diplomacy During the Late 1980’ s,” July 1989 manuscript, provided to OTA by
the author, who is a senior vice president of Kemper Financial Services, Inc.
~Testimony on Oct. 17, 1988.
35s~ went t. ~efica~, 4 t. British ~, ~d 2 ~ch to Fr@ch, W=t ~~~ ~d Swiss f-. Motohiro IIca, “Foreign SCZWM= Fhms,”
The Japan Economic Journal, Summer 1988, p. 39.
36~s is an~om~ jomst~s es~te; .s= ‘fc~Japan7s Saties F~ Keep theFlag Fl@g?” The Econo~”st, Dec. 3,1988, pp. 85-86. OTA
was unable to obtain this information from the Japanese firms.
37Cr~g Fo- “Merrill ScaleS Down Imndon ~itbm,” The Wall Street Journal, June 15, 1988, p. 20.
38Forei~ exc@e ~s 1oW ken a ~how _ket. About $350 bil~on ~ fo~i~ c~ncy tr~sactiom tie pla@ ev~ @, colllp~~ tO d)ollt $5
billion daily on the NYSE. S. HanSell, “The Computer That Ate Chicago, “ Institutional Investor, February 1989, pp. 181-188.
sgGzo&z capital Mar~et~, ~ ~MG rqo~ (~ter~: KPMG ~t~tio~ ~lce, peat -ck McL,titock Publications, 1988), p. 16.
 Chapter 3--The Extent of International Securities Trading ● 33

Figure 3-4-Trading Around the World and Nearly Around the Clock

Keyed to eastern daylight time/local hours shown adjacent to each session —

I I I I I I I I I I I 1 I I I I I I I I I
9 Midnight 3 6 9 Noon 3
1
Tokyo I I IClosed\ I 9 to 11 a.m.; 1 to 3 p.m. I I

Hong Kong

London
T+’+ Closed

9 a.m. to 5 p.m.
10 a.m. to 12:30 p.m.; 2:30 to 3:30 p.m.

New York
—
SOURCE: Office of Technology Assessment.

will probably not be a major barrier if 24-hour The most extensive, vigorous, and competitive
trading turns out to be profitable. 24-hour trading (except for currency) may eventu-
ally be in futures contracts.41 The Nikkei index is
Richard D. Ketchum, Director of the SEC’s
traded on the SIMEX exchange in Singapore, as well
Division of Market Regulation, claims that for most
as Osaka, and is approved for trading on the Chicago
equities there will not be sufficient 24-hour order
Mercantile Exchange (CME). LIFFE trades Japan’s
flow to encourage profitable risk-taking by market
government bond futures and the Chicago Board of
makers. This is different, he points out, from foreign
Trade (CBOT) announced (Nov. 21, 1988) that they
currency and government bond markets ‘‘where
would also do so. When CBOT expected that TSE
ownership of the underlying assets have truly spread
was about to begin trading a T-bond futures contract
worldwide and relevant news regarding those mar-
in competition with CBOT’s contract, the Chicago
kets occurs around the clock and around the globe."40
exchange responded by beginning to trade during
This projection too depends on continuation of
evening hours, 6 to 9:30 p.m. c.s.t., Sunday through
present conditions of ownership and information
Thursday. Four months later, the Philadelphia Ex-
flow that tend to concentrate liquidity primarily in
change began operating from 7 to 11 p.m. e.s.t.,
one home market. These conditions may already be
Sunday through Thursday and from 4:30 to 8 a.m.
changing.
e.s.t., Monday through Friday, to accommodate
U.S. broker-dealers may be likely to try 24-hour traders in London and Tokyo. Thus, competition
trading because they already have a large investment among exchanges, or the fear of it, is stimulating
in information technology. Salomon Brothers opened 24-hour trading.
a 24-hour desk in New York when the Chicago
Board of Trade began evening trading in May 1988. The New York Stock Exchange may find it
Their business in futures and options is covered from difficult to extend its trading hours because of its
New York during the hours that the U.S. or Tokyo labor-intensive trading system.42 It will be hard to
markets are open, and from London when the find a second shift of specialists, at least until
London International Financial Futures Exchange 24-hour trading has become a highly developed
(LIFFE) is open. activity-and then it would probably be too late to

~S@tement by Richard G. Ketchum, “Challenges Facing the StZdkX Musq,” at a meeting June 16, 1989, sponsored by Business Week and
Securities Week, manuscript provided to OTA by the author. The statement represents the personal views of the author, not a statement of SEC policy.
41~fiu~N~@wachi, ” Financial Futures: Round-the-Clock Trading Expected to Spread in Tokyo,” Tokyo FinancialMarkets, a Special Survey
of The Japan Econonu”c Journal, Summ er 1988.
42The NYSE us a ~fis~ or desi~t~ mmket.~er, system ~d hades must go ~ugh he sp$cfit post (with some (XCeptiOnS) when the
floor is open for trading. Floor trading is supported by automated order routing systems and other forms of automation. See OTA’s forthcoming report
on information technology and domestic securities markets.
34 ● Trading Around the Clock: Global Securities Markets and Information Technology

capture this market. Under the pressure of rapid London Traded Options Market (LTOM) trades
development of international trading, however, the options on equities and a stock index. There are
NYSE has recently announced “plans to explore others in Stockholm, Zurich, and Denmark; options
off-hours trading.” According to James Cochrane, markets are planned in Finland, Norway, and
the Exchange chief economist: Ireland. Trading in options began in Japan in June,
1989, at the Osaka Stock Exchange, with a contract
By working with industry participants and ex-
change customers to assess current off-hours activ- based on the Nikkei 225 index, but there was already
ity, trading procedures, and market needs, the NYSE a large volume of off-market (private) options
is developing a strategic approach to emerging trading.
global markets. What roles extended hours, available
The U.S. Commodity Futures Trading Commis-
technologies, and key market participants will play
in these strategies have not yet been announced by sion (CFTC) and the SEC have both approved the
the Exchange.43 CME’s plan to trade a futures contract based on
Morgan Stanley Capital International’s index, repre-
senting a basket of 1011 stocks issued in 18
Product Links Between Markets countries. The Coffee, Sugar & Cocoa Exchange is
now trading a futures contract based on its Interna-
Non-American exchanges are copying innovative
tional Market Index (50 foreign stocks primarily
instruments developed by the U.S. exchanges. The
available only outside the United States), and
chairman of CBOT has complained that “[CBOT]
AMEX is trading an options contract also based on
contracts are being Xeroxed overseas. ”44 There are
that index.
many new derivative products (futures and options)
markets in Europe, Scandinavia, and Japan, at least Whether these index futures or option contracts
36 in all outside the United States. Chicago markets will succeed remains to be seen. There may not be
did more than three-quarters of the world’s futures enough buyers and sellers to assure liquidity. On the
trading only 5 years ago. This was down to 60 other hand, institutional investors may use them to
percent in mid-1989, and the TSE’s yen government provide “an international component” to hedge
bond futures contract is now the world’s most portfolios, or for other trading strategies such as
heavily traded. The rapid spread of derivative asset allocation. Some institutions are prevented by
products markets in competition with U.S. futures local law or by their charters from investing abroad,
and options markets has stimulated a greater willing- but would be able to use these U.S. futures contracts.
ness at the CME and the CBOT to try technology as
a way to compete in the international arena.
Multinational Initial Offerings
The French MATIF, opened in 1986, is now the
Initial stock offerings on a multinational basis
third largest futures exchange in the world. The
also encourage international trading. Many coun-
fourth largest is the London International Financial
tries do not have enough depth in their capital
Futures Exchange (LIFFE), which is trading, among
markets to accommodate large new equity offerings.
other non-sterling products, a futures contract on
France, for example, was faced in 1986 with
10-year German Government bonds. A contract on
privatizing companies worth about $30 billion, at a
the same German lo-year bonds will be traded by the
time when the total value of listings on the Paris
West German Deutsche Terminborse, which opened
bourse was only about $80 billion.% Very large
in January 1990 as a fully computerized exchange,
issues of stocks may be underwritten in several
operating through monitor screens connected to a
countries at the same time. Multinational offerings
central computer.45
are often underwritten as different tranches with
The European Options Exchange in Amsterdam separate underwriters. They are increasing as corpo-
was the first in Europe, and has many international rations seek to diversify their stockholder base, to
links. MONEP is the French options exchange. The increase the recognition of their products and

As~ner t. OTA Aug. 14, 1989.

~Ja_ti ~=, “fitures and Optiom, “ Financial World, Aug. 23, 1988, pp. 27-29.
4S~o~on ~ovid~ ~ OTA ~ Me~gese~c~ COrp., New York NY, NOV. 23, 1989.
%roup of Thirty, “Symposium Background Paper: The Globalization of Equity Markets,” Imndo% Sept. 15-16,1986.
 Chapter 3-The Extent of International Securities Trading ● 35

services in a broader market, to fund foreign RISKS INHERENT IN

employee benefits schemes, to facilitate foreign
acquisitions, or to defend against take-overs.
GLOBALIZATION OF
SECURITIES MARKETS
If all of the legal, regulatory, and social barriers to
International Mutual Funds globalization of securities trading are overcome,
important systemic risks remain. In times of crisis,
These are an alternative to active portfolio trading the failure of major intermediaries could “impose
and let investors hedge against changes in one unacceptable external costs on the entire financial
country’s economic conditions without the disad- and payments system and ultimately on the entire
vantages of trading in a foreign country with economy. ’ ’49 There is a strong trend toward concen-
insufficient information. Some European countries, tration and consolidation of securities firms, so that
especially Luxembourg, have tried to get American the failure of any major intermediary will be likely
investment companies to offer U.S. mutual funds in to have wider consequences than in the past,
Europe, but legal and tax differences make it especially when such intermediaries deal in many
difficult for U.S. mutual funds to operate in Eu- markets or in many nations. There was no cascade of
rope. 47 failures when Drexel Burnham Lambert went bank-
rupt, but this is little assurance that it could not
happen in the future.
International mutual funds managed by U.S.
investment companies for American investors be- Several kinds of risks are inherent in securities
came popular in the early 1980s as the dollar trading and are likely to be affected by an increase
weakened (as foreign currencies appreciated against in translational securities activities. They include
the dollar, the net asset value of funds denominated credit risks, position risks, transaction risks, and
50
in those foreign currencies increased). While returns systemic risks.
for many international mutual funds have been
Credit risk (also called counterpart risk) is the
superior to most U.S. funds over the last 5 years,
possibility that one party to a transaction may not
some investors in international mutual funds were,
deliver, or that a borrower may not repay a loan, or
however, reported to be disappointed as it became
that an intermediary in a transaction (e.g., a payment
clear that diversification does not necessarily avoid
bank or a clearinghouse) may fail. This risk is much
cyclical risk (for example, the recession of 1982 and
the same in domestic and international trades, but it
the crash of 1987 were worldwide).48 The funds are
may be made worse by internationalization because
also highly vulnerable to currency fluctuations.
it is harder to make judgments about the reliability
Third World country funds are relatively thinly
of counterparties, the quality of assets, or the degree
traded; large infusions of money, from a pension of protection afforded by disclosure rules. Credit
fund, for example, can swing the market violently, risk is increased as participants trade in several
and under stress it can be difficult to get out of the domestic and foreign markets, where regulatory
market because there are too few potential buyers. standards and safeguards may vary widely. (See ch.
4.) On the other hand, greater opportunities to
The number of international mutual funds never- divers@ activities may help to reduce total credit
theless continues to grow. The Investment Company risk. Many countries are now acting to improve their
Institute says there are 75 international funds (two- clearing, settlement, and payment mechanisms, and
thirds of their portfolio from outside the United in some cases the sharing of information (see ch. 5),
States) and 80 global funds (some U.S. securities). and this should moderate the increased credit risk.

dT_tiomofmu~= ~mmew~t~mn~ a,sarerequirernents foraccounting procedures and for disclosures, andfort.hetimes whm~iti
gains must be paid out.
4sKenne& J@wU ~d Jeff ~d~ “IIItemtiorMI Funds: What Factors A.ff=t Thd Returna,” AMA JownaZ, my 1988, p. g.
4g&_tion for ~n~c ~o~on ~ ~elopmen~ ‘$~wemnts for the R-bon ~ Sup-ision of Securities ~hts in OECD
Countries,” Financial Market Trends 41, Novembex 1988, p. 36.
SOS- remarks made by Grant L. Reu@ ~Uty ~ of the Bank of Montreal, at a F“mancial Globalization Conference in Chicago, Nov. 2,
1989; the address was entitled “Implications of Globalization for Regulation.”
36 ● Trading Around the Clock: Global Securities Markets and Information Technology

Position risk is that which threatens entire institu- power, causing blackouts and making it impossible
tions with sudden failure: insufficient assets to meet to depend on electric systems in the financial
the demands of depositors, borrowers, investors, or Sector. 51
creditors. This could be associated with: 1) a drying
In addition, dependency on technological systems
up of liquidity (when assets exist but cannot be
increases the vulnerability when the system fails,
reclaimed and redirected), 2) significant change in
because manual skills, interpersonal relationships,
the value of securities being held for trading or other
and alternative means of operating have often been
uses, or 3) adverse changes in foreign exchange rates
forgotten or lost. In global trading, some of these
or interest rates. International trading can reduce
alternative and backup procedures have never been
position risk by offering a greater choice of markets,
developed. At the same time, expectations of speed
more opportunities to hedge, and a greater variety of
and efficiency have increased because of technol-
trading strategies. On the other hand, globalization
ogy, and so the impact of breakdown maybe greater.
of markets tempts traders to trade in environments
where they do not understand all of the dangers and There is a further risk of unknown dimensions that
may lack buffers such as back-up lines of credit. comes with internationalization--sy stemic risk. That
is the extent to which securities market credit,
Operational risk is the danger that comes from
position, or transaction risk could threaten the basic
breakdowns in telecommunications, computer sys-
financial industries, the payment system, or the
tems, established institutional procedures and struc-
economic performance of nations. On this question
tures (including market-making mechanisms), and
there are many opinions but little useful evidence.
other “mechanical” aspects of securities trading.
There are two complementary approaches to reduc-
Technology provides powerful capabilities for get-
ing risk: 1) private sector efforts to improve and
ting things done, and for guarding against the human
strengthen both technological systems and institu-
risks of error, inattention, incompetence, misfea-
tional interfaces, and 2) governmental efforts to
sance, and malfeasance. But technology entails its
improve and harmonize regulatory safeguards. Many
own risks of breakdown and misuse, which almost
countries are now revising their regulatory frame-
certainly increase with internationalization. Techno-
works. According to the Organization of Economic
logically sophisticated systems have failed in all
Cooperative Development:
countries, including the United States, for example,
telephone networks, electric power distribution sys- There is increasing awareness that securities
tems, and air traffic control systems. The ability ’to market activities involve risks that are comparable to
develop and maintain technological systems is not the systemic risks inherent in banking, and that
the same in all countries. Technological backups accordingly, the basic question arises as to what
may be inadequate or untested, or may fail for the extent existing regulatory and supervisory arrange-
ments are adequate to deal with current market
same reasons that the primary system fails. In late
realities. 52
1989 and early 1990, for example, a severe drought
in the Philippines caused a shortage of hydroelectric These efforts are discussed in chapter 6 of this report.

Sl~rd@ to w ~ m- Vice President for International Development International S=tities ~- COT., MY lm.
%3EcD, op. cit., footnote 49, p. 31.
 Chapter 4
America% Competitors in Global Securities Trading

In the competition for leadership in global securi- information technology and from prudential regula-
ties trading, America’s chief competitors at present tion that assures transparency and fairness.
are Japan and the United Kingdom. 1 The European
Community is making a strong effort to integrate
and strengthen the securities markets of its member JAPAN
nations (which include the United Kingdom) into a The Tokyo Stock Exchange (TSE) was the
trading arena that can compete on equal terms with world’s largest market in value of investments from
the United States and Japan. There is much skepti- 1987 to early 1990. It had been a bull market for 7
cism, even among proponents, that this can be years, growing from $370 billion in 1980 to $2,803
achieved in the near future, but the EC countries, as billion in 1987, interrupted only briefly by the
well as other nations such as Canada, Australia, October 1987 crash. In February 1990, its prices
Singapore, and Hong Kong are, or could become, began a steep, spasmodic decline. This had little
niche competitors.
immediate effect on other major markets, but some
Institutional investors have the incentive, the experts worry that if the Japanese market should
information access, and the technological infrastruc- really crash, its investors might be forced to pull
ture to trade across national boundaries. In making their money out of other markets to cover the losses,
the decision to do so, they balance several factors: causing the crash to spread around the world.
price, liquidity, cost (including regulatory costs),
The TSE traces its institutional history back to
and safety (i.e., transparency and fairness). Some
1878, but it was organized in its present form during
markets with high investment returns are limited or
the United States occupation of Japan, and stock
risky.
trading began in April 1949. There are several
The conventional wisdom about market liquidity exchanges in Japan, but the TSE handles about 86
has been that the trading for a specific security will percent of transactions by volume and by value. The
always concentrate in one marketplace. With tech- Osaka Exchange accounts for roughly 10 percent,
nology making possible nearly instantaneous com- the Nagoya for about 4 percent, and others less than
parison and arbitrage of prices (eventually on a 1 percent together.2 The TSE is described in its own
24-hour basis), that rule may not forever hold true. literature as a quasi-government organization, and
There could be more than one liquid market, or the ‘‘a place for domestic and foreign investors to invest
active market for a stock may migrate from one their assets . . . [and] by making it easy for enter-
country to another or from one time zone to another. prises or the nation to raise capital, it also makes an
important contribution to economic development. ”
The serious constraints on international trading at
present are the lack of essential protective regula- Traditionally Japanese corporations depended
tions or enforcement in some countries (see chs. 3 heavily on debt financing (typically less than 20
and 6), and clearing and settlement risks (see ch. 5). percent of corporate capital has been equity); and
As these barriers are reduced, competition to serve most of that came from banks rather than from
international investors will increase. In this competi- securities markets.3 But large Japanese firms now
tive arena, the United States’ position may depend raise over 60 percent of their funds in the capital
ultimately on the advantages it can get from market. 4

1~ ~~pt= &aw~ on ~v~ o~ ~on~ctm ~fis, including: ~c K. Clemom, princip~ hvestigator, with Stephen P. Broad, Rav’i
%dcateswara~ and Bruce W. Weber, “Globalization of Securities Markets”(Philadelpl@ PA: Wharton School, University ofPennsylvan@ July
1989); Peter Schwar@ “Scenarios for Regulation of International Securities Trading” (San Francisco, CA: Global Business Network NOV. 3, 1990;
Manning Gilbert Warren III, “Securities Regulation in the European Communities” (lhscalooa AL: University of Alabama Law Schoo~ August
1989).
~okyo Stock Exchange, 1989 Fucf Book, p. 17.
sThe GT GuUe to World Equity Markets J988 (lmndon: Euromony publications, 1988).
ds~t~ent by ~~o Kadoti, of~e ~s~ of F~ce, ~ tie 14~ ~USI Conference of IOSCO, in Venice, Sept. 18-21, 1989.

–37–
38 ● Trading Around the Clock: Global Securities Markets and Information Technology
—

Recent Trends on the relatively few Japanese institutional investors

seeking short-term profits. This usually means
TSE began trading foreign stocks in December buying and selling Japanese securities, because
1973, with six listed foreign stocks. 5 In 1985 the information about them is most quickly available.
number began to rise dramatically, and reached 120 Foreign investors for the last 5 years have been net
by early 1990.6 The average daily turnover of sellers, and their share of trading has fallen from 10
foreign stocks is about 790,000 shares compared to to 2 percent.
over 1 billion total daily volume.7

Japan’s primary market for government bonds How the Market Works
was virtually closed to foreigners until 1986. When Trading at the TSE takes place as a continuous
there was a new government bond issue, Japanese order-driven market, where buy and sell orders
banks, securities firms, and life insurance companies interact directly. There are no official market-
would form an underwriting syndicate and divide up makers, no specialists, and no affirmative obligation
the issue among themselves for distribution.8 For- to make markets. All securities must be traded
eign banks and securities firms were not members of through an authorized securities dealer. The Big
the syndicate but were occasionally allotted a small Four securities houses: Nomura, Daiwa, Nikko, and
part of the issue. In 1989, Japan moved to a partial Yamaichi, together account for about 40 percent of
auction system for selling 10-year bonds. the trading, for their own accounts and for customers
The number of foreign member-firms on the TSE (in 1960, the same four firms accounted for 70
has increased slowly, to 22 in 1989. After the stock Percent) .11
market crash in 1987, the 45 foreign securities firms In Japan, institutions and corporations hold the
in Tokyo began to reduce their staffs. In the year majority of stocks, but tend not to trade them.
ending September, 1988, 39 of the 45 foreign firms Individuals do most of the trading. Ownership of
in Tokyo had net losses, but during the next year, shares of companies listed on the eight exchanges in
they were by most accounts doing well. 9 They Japan in 1988 was as follows:12
account for only about 5 to 7 percent of trading
Percent
volume, possibly because they lack good retail Banks and other financial institutions . ..........44.6
channels (the active sector of the market is trading Business corporations . . . . . . . . . . . . . . . . . . . . . .. .24.9
by individual investors). Individuals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23.6
Foreigners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.6
The TSE still has fixed commissions (except for Securities firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.5
large trades, for which commissions have recently Investment trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4
been unregulated). Traders try to turn over as many Government/local government . . . . . . . . . . . . . . . . . 0.8
shares as possible, as often as possible, to capture
gains, because the ratio of dividends to prices is very There are two kinds of exchange members-
low. 10 Both domestic and foreign traders concentrate regular and Saitori. Regular securities company

%lb&o Stock Exchange, 1989 Fact Book, p. 19.

6Da~ ~ppfi~ by ~+ Yuji Shibuya of the Nom= Re-h ~ti~te, Tokyo, F= 81.2.277.~98, NOV. 15, 1989, updated co-sy Of the
International Securities Clearing Corp., May 1990.
7~@o f$t~k Exchange, 1989 Fact Book.
KO Sakai, “GovernmentBondM arket: More Liberalizadon Measures Urged ’Ib Raise Foreign Share,” TheJapanEcononu”cJournal, Summe r 1988,
p. 28.
Whe Wall Street Journal, reported on Aug. 16, 1989, that Salomon Brothers, Merrill LyncQ Goldman Sachs, and Morgan Stanley Japan Ltd. are
doing well in Jap~ but “on the whole, foreign losers vastly outnumber the winner S. (Marcus W. Brauchli, “U.S. Brokerage Firms Operating in Japan
Have Mixed Results,” p. 1. See also “Gaij@ Gaij@ Gone,” The Economist, Jan. 14,1989, p. 69. In 1990, most new reports say that Anerican securities
firms in Tbkyo”are making money. (Financial Tz”mes Special Section on Japanese Markets, III-ix, Mar. 15, 1990.)
~oshuo N~@_ ~~~~~e of the~nt si~tion and the ~blems of ~vestorRo~tion in Jap~,” present~ at the NASAA Conference
in Washingto~ DC, Apr. 26, 1990.
llR~Bro~ *+M~m.S~~FirmS prO~~u@~irB_ L*,” Fi~nciaJTj~s, s~i~ Sect.iononJapanese Markets, @. 15,1990,
HI-vi. “
12These fiWes ~ from ~ TSEJ’act Book J989, p. 92, which d~s not expl~ why they add to lo2.Apercent. It is likely tit “investment h’llsts,
2.4 percent” overlaps with the figures for banks and other financial institutions, Foreign ownership peaked in 1984, at 6.3 percent.
 Chapter 4--America’s Competitors in Global Securities Trading ● 39

members, like broker/dealers in the United States,

receive orders from customers or trade for their own
account. They execute trades through four Saitori
members, who match buyers and sellers. Saitori
members are not analogous to U.S. market-makers
since they can neither trade for their own account nor
accept orders from public investors. They record a
match of buy and sell orders but do not become a
counterpart to a trade.

In executing large block orders (300,000 shares or

more), a regular member can act as both seller and
buyer. However, in active stocks the proportion of
block trades was only 6.5 percent in 1988,13 because
institutions tend not to trade as much as individuals. Photo credit: Courtesy of Tokyo Stock Exchanges

TSE trades only listed securities, and a decision Tokyo Stock Exchange computer-assisted trading room
by the Exchange to list a security must be approved
by the Minister of Finance. Listed foreign stocks and . Second Section stocks (434 listed), all trade on
bonds may be denominated in either yen or foreign CORES; and
currency but exchange settlement is chiefly denomi- ● Foreign Division listings (120),also trade on
nated in yen. Japanese stocks often trade at much
CORES.
higher price-earnings ratios than American stocks,
averaging 65: 1 as compared to 12: 1 at the New York Of the 1,723 listed issues in 1989,1,573 are traded
Stock Exchange (NYSE), in part because earnings only electronically. However the other 150 issues,
are not consolidated due to corporate cross-listing which trade on the floor, represent about 78 percent
and in part because of differences in accounting of all trading volume by shares. 14 Stock Price display
practices. boards immediately display the price information.
The layout of the Exchange floor is much like that of
Most of the stocks are traded only on the the NYSE, but the hand signals used by the traders
Computer-Assisted Order Routing and Execution are more like those used at the Chicago futures
System (CORES). Exchange member companies exchange.
have on-line terminals in their main offices to send
in orders and receive verification. In the TSE Only First Section stocks can be traded on margin.
Computer-Assisted Trading Room Saitori clerks The customer deposits guarantee money at a pre-
monitor the computers, which automatically match scribed rate with the securities company, and can
orders on their “Book Display Device” or display also use securities as collateral (they are given a
screens. When a transaction is completed, the notice special “loan value”). The customer pays interest
is sent to a Trade Report Output Device in the office until he returns the money borrowed from the
of the firm that placed the orders, and recorded on the securities company. For individual investors, about
Saitori members’ Trade Report Printers. 39 percent of transactions were margined in 1988, an
8 percent increase in that year. The use of margins
There are three kinds of stocks: had been declining since 1982, although the value of
margined transactions had continued to rise (as
. First Section issues, the most actively traded much as 39 percent in 1988). 15
stocks (1,169 in 1989), of which only the 150
most “blue-chip’ trade on the stock exchange A market information system conveys quote and
floor, while the rest trade on CORES; price information to the offices of the securities

ls~~o siti ficha~e, Fact Book 1989, p. 16.

14~~e f@e~ ~em ~ppli~ by NOm~~ R~~h ~ti~te, NW Yom ~, J~~ 1990+ ~C TSE Fact B~~k 1989 tists comparable fi~ fOr
1988: of 1,8(X2 listed stock (1,690 domestic, 112 foreign), 1,652 am traded on CORES and 150 on the floor.
15T@o Stock Exchange, Fact Book 1989, p. ~.
40 ● Trading Around the Clock: Global Securities Markets and Information Technology

Photo credit: Courtesy of Tokyo Stock Exchanges

Tokyo Stock Exchange stock trading floor

companies, the media, and information vendors as selling at a much lower price.) Finally, there are
well as to the stock price display boards on the temporary trading halts when the market becomes
trading floor. However, no vendor is permitted to too volatile.
provide real-time digital price or quote streams to
investors away from the floor.
Derivative Products Markets
The bond trading floor is much like the stock
trading floor. Member companies place orders by In 1985 the Tokyo Exchange started anew market
telephone directly to Saitori members in a special for long-term Japanese government bond futures.
government bond block trading room. However, Trading is conducted largely by computer. In 3
most bond trading is over the counter, including years, this has become one of the major financial
large block trading in government bonds and yen- futures markets of the world. Access to futures
denominated foreign bonds. trading is open not only to regular member firms, but
also to non-member securities companies and banks.
Since there are no market-makers or specialists in
the TSE, the function of keeping an orderly market In June 1987, the Osaka Securities Exchange
is handled in other ways. 16 When there is a major began trading on stock average futures, using a
order imbalance in a listed stock, the Exchange posts bundle of 50 blue-chip stocks traded in Osaka.
a “special bid quote” or a “special asked quote” Trading in cash-settled TOPIX futures at the Tokyo
that is better than the last sale price. This can be Exchange and the Nikkei 225 futures at the Osaka
renewed or modified every 5 minutes until it elicits both began on September 3, 1988.17 This was
enough orders to reestablish some equilibrium. described as an opportunity “to offset general
Another way of controlling ups and downs is the market risk, gain financial protection, maintain
daily price limit (which is imposed on the basis not profitability, invest in the market as a whole, and
of a percentage change in price but an absolute yen arbitrage between futures and cash markets. ’ A
limit). Listed stocks cannot be traded at a price that representative of the Ministry of Finance, Sadaaki
exceeds the limit of price fluctuation from the Hirasawa, said that government policy would en-
closing price of the previous day (the permitted courage the development of futures markets with
fluctuation is proportional to the price level, i.e., a “high priority for protecting the position of inves-
high-priced stock can fluctuate more than one tors and other market participants.”18

1%id., p. 12.
IT~e Nikkei AverWe Share Wce ~dex is simih to the Dow Jones, and is built on the prices of 225 First Section stOckS. The prinCipd d~culty
with tbis index is that it is not weighted and the Tokyo stock price index (TOPIX) was developed in 1969 to remedy this-it is the weighted average
of all First Seetion stocks.
~ssa- fimaw% “Catc@ UpFaS~” Look Japan, July 1988, p. 10.
 Chapter 4--America’s Competitors in Global Securities Trading ● 41

But on December 8,1988, the Nikkei 225 first fell was again blamed for the break. The Tokyo Stock
nearly 200 points in the first 15 minutes of TSE Exchange imposed restrictions on computerized
trading and then jumped 300 points in the final 30 program trading between the futures and cash
minutes. Program trading led by U.S. firms was markets, and the Ministry of Finance was reported to
blamed. On the day before, there was an unprece- have called in large institutional investors and
dented volume of trading in stocks, as traders took leading brokers to discuss the market situation. 23
advantage of price differences between stocks and After further declines in the market, U.S. firms were
stock-index futures on the first contract expiration asked in early March to restrict their program
date for contracts. trading.24

A month later (Jan. 13, 1989) the president of the It is thought that program trading in Japan is
exchange said publicly that the exchange might mostly done by U.S. fins. To do program trading,
move to restrict arbitrage trading between stocks and brokers need to sell huge blocks of stocks, which
stock-index futures because arbitrage by foreigners may depress the prices of those stocks. In Japan,
might induce “excessive volatility and confusion.’ ’19 companies may identify which broker was selling
Before Japan’s second witching hour, March 7, the stock and punish them by withholding under-
1989, there was worry that a sell-off could drop the writing or other business from that company. The
Nikkei by as many as 1,000 points. Accordingly, the U.S. firms say, however, that much of their program
exchange followed the example of the Chicago trading is on behalf of large Japanese insurance
Mercantile Exchange and changed the rules so that companies and trust banks.25 In the midst of the
the settlement price for TOPIX futures is based on renewed controversy about program trading, in
the opening stock prices the day after expiration. The March 1990, Nomura Securities Co. (the largest
Exchange also changed stock margins from 30 to 40 securities firm in the world) announced that it would
percent.20In December 1989, two New York firms— begin program trading, and had hired an experienced
Salomon Brothers and Morgan Stanley-who had American securities expert to oversee their new
publicly announced that they would cease program activity .26
trading in the United States, were reported to be Futures and options trading, nevertheless, is
actively program trading in Tokyo, arbitraging growing rapidly. 27 Three index options contracts
between the two stock indexes, the Nikkei and began trading in mid-1989. The volume of trading in
TOPIX.21 The vice-chairman of Salomon Brothers, the most popular of these, the option on the
Stanley Shopkorn, was quoted22 as saying, Nikkei-225, has grown to about 65,000 contracts per
The Japanese have an ability to monitor and make day.
sure the market works in a more orderly fashion.
They don’t have the fears that U.S. investors have Over-the-Counter Market
regarding index arbitrage.
About 250 companies are listed on Japan’s
But on February 26, 1990, after the Tokyo market over-the-counter market; to be listed requires that an
28
dropped by 11.5 percent in a week, program trading average 2,000 shares are sold per month. This
19@o~d h C’~@o &change my Act To Curb Arbitrage Trades,’ Wall Street Journal, Jan. 13, 1989p. C 14,
and Cmdle, “ The Economist, Mar. 4, 1989.
m,4By BeU, Book,

Z1-CU.S. Fi.rms Using Rogram Trading Make Tokyo Stock MarketJumF,” Wall Street Journal, Dec. 9, 1989, p. C 1.
22SW B@ett, “~@ fibi~ge for U.S. Finns, ” New York Times, Dec. 19, 1989, p. D 5.
23~c.yo N_o~ and st~anwags~l, “~~o Curbs Arbi@age “f’rading,” Financial Times, Feb. 27, 1990, p. 1.
~WCUS Brauchli and Masayoshi Kanabayasbi, “U.S. Brokers Asked in Japan lb Curb Program Trading, Wall Street Journal, Mar. 9, 1990.
~Ibid.
~~c~el R. Sesit and Craig l’brres, “Nomura To Plunge Into Program Trading on Global Scale, Challenging U.S. Lead,” The Asian Wall Street
Journal Weekly, Mar. 19, 1990, p. 27.
27Tr~ding fi the N&k&225 ~d TopJ’x fi~~ contracts, added togeth~, is now higher ~ trading in the U.S. Stintid & poor 500 index flltur~

(according to Andrew Freemam “Japanese Contracts Could Overtake U.S. Equivalents, “ in the special section of Japanese markets, Financial Times,
Mar. 9, 1990) but such comparison can be misleading. Because of differences in U.S. and Japanese margining systems, it is customary to sell and
repurchase more frequently, to capture profits.
~Assetznternational, NOV. 20, 1989, P. 9.
42 ● Trading Around the Clock: Global Securities Markets and Information Technology

market grew at a rate much slower than expected clearing organizations, securities depositories, and
until mid-1989, but thereafter became more active. commercial banks that keep the underlying foreign
The Japan Securities Dealers Association has devel- shares in the home country.
oped anew electronic quotations system modeled on
29
the NASDAQ (National Associates of Securities Market Regulation
Dealers Automated Quotation) system in the United
States; it will be called JASDAQ. The TSE is a non-profit corporation, self-
regulating but under the close supervision of the
The over-the-counter market was the locus of the Ministry of Finance. Many changes have been made
“Recruit-Cosmos” influence-peddling scandal, in in the regulatory and tax structure since 1987.
which senior government officials, including the Exchange members themselves proposed new rules
finance minister, made large profits by buying a to curb stock manipulation, to make initial public
company’s stock just before, and selling it just after, offerings more competitive, and to dismantle proce-
it was approved for over-the-counter sale. The Japan dures that allow stock to be transferred to selected
Securities Dealers Association, which is the self- people at advantageous prices (as in the recent
regulatory organization for the over-the-counter Recruit-Cosmos scandal).
market, has now proposed new, tighter, regulation to
prevent this kind of insider trading. TSE publications prominently emphasize a deter-
mination to guarantee the public interest and protect
Clearing and Settlement investors, and they tie this to “the principle of
auction,’ which is defined as time and price
All clearing and settlement for stocks is handled priority. Rules say that financial statements
30
and
by the Japan Securities Clearing Corp. (JSCC), a
any other company news that may influence the
subsidiary of the TSE, and is usually done on the
prices of securities must be “disclosed accurately,
third business day after the trade. The failed-trade
rate is less than 1 percent. Recently, high volumes of
promptly, and impartially, at the appropriate mo-
ment without delay. ” Nevertheless the Japanese
trading are pushing this system to its limits, and a
“back office” (after-the-trade paperwork) crisis is
markets are far from transparent. The Ministry of
threatened. (See Appendix A: Clearing and Settle-
Finance announced in January 1989 that it would
ment, for a detailed description.)
tighten stock-ownership disclosure rules, making
31
them similar to U.S. and British regulations.
There is a book-entry clearing system; however,
Although insider trading has always been against
JSCC is technically required to return the deposited
share certificates to the owners once a year and
the rules, neither violations nor reprimands were
whenever a shareholder requests it. This is a major
made public, and most market participants report-
burden on the institutions and the market. Discus-
edly did not consider them a serious violation of
sions on how to improve the system have gone on for
either law or ethics. In early 1989 Japan for the first
many years. A Central Depository and Clearing of
time provided criminal penalties for insider trading.
Securities Law was enacted in 1984, but the new
Japan’s Securities Exchange Act of 1948 has many
investor protection clauses patterned after those in
Depository Center that it sought to create is not yet
operating; it may begin in late 1991. Settlement
U.S. laws, but according to a leading Japanese critic
costs in Japan are very high compared to other
of the markets, the
32
laws ‘‘have not been satisfacto-
rily enforced.” Shuzo Nakashima, of the Hiji-
markets.
ribashi Law Firm, identifies two reasons for this: 1)
For foreign stocks, clearing and settlement is because of cross-holding of shares among corpora-
through full book-entry transfer at the JSCC, which tions, the interests of other shareholders can be
has cooperative agreements with overseas public “ignored and neglected most of the time’ and 2)
~SOmS: “Regulations of the Tc@o Stock Exchange,” 1986; “Constitution of the TolqIo Stock Exchange,” 1986; “Listing Regulations of the
‘Ibkyo Stock Exchange,” 1984; “A Listing Guide for Foreign Companies,”no date; all supplied by the ‘lbkyo Stock Exchange.
-t is, the lowest-priced offer and the highest-priced bid hasfnt priority, and if two are placed at the same price, priority is given to that received
first.
qltis W. Bmuchl~ “Jap~~e Regulators Seeking lb Tighten Rules orMtock-Ownership Disclosure, “Asian Wall StreetJournal, Jan. 23,1989,
p. 18,
32N~ op. cit., footnote 10.
 Chapter 4--America’s Competitors in Global Securities Trading ● 43

enforcement is neglected because the regulating Most of Tokyo’s trading is concentrated in a few
authority (the Securities Bureau of the Ministry of major issues; the 30 most active stocks account for
Finance) is chiefly concerned with the growth of the about 46 percent of volume by transactions and 39
Japan securities industry and its brokerage firms. percent by value. No one is allowed to deliver
Mr. Nakashima lists as major problems insider real-time digital price data by electronic systems to
trading, price manipulations, churning, and fraud by investors. Frequent trading halts may alarm some
securities advisers. foreign investors who are not accustomed to circuit-
breakers. There is a trading tax in Japan, of 0.30
Japan, like the United States, legally separates percent of the value of the transaction. Commis-
banking from securities markets, the Glass-Steagall sions, particularly for retail customers, are high
Act having been the model for Japan’s Article 65,
compared to other markets, and the paper-based
adopted during the American Occupation. As in the settlement system, which does not centralize settle-
United States, this separation has been made less ment between brokers and custodians, is expensive
effective by a combination of deregulation and
for institutional traders. Investor protection is weak.
technology. The largest banks are demanding uni-
So long as Japan’s economy is strong, however, its
versal banking (i.e., permission for banks to engage securities markets will continue to be strong compe-
in all kinds of financial activity, including securities
tition for those in the United States.
trading) while the securities firms want to preserve
the separation. The Ministry of Finance is reported
to be considering a compromise in which banks THE UNITED KINGDOM
could set up brokerage subsidiaries and securities
33 London is the other major competitor to New
firms could open bank subsidiaries. York stock markets and Chicago futures markets in
This issue has been complicated by the impending world trading. The International Stock Exchange of
introduction of GLOBEX (discussed in ch. 2), the the United Kingdom and the Republic of Ireland
%
electronic trading system being introduced by the (ISE, or informally, the London Stock Exchange)
Chicago Mercantile Exchange and Reuters. Japa- is the most “internationalized’ of the major mar-
nese banks began planning to put GLOBEX termi- kets, with 1,987 domestic and 707 foreign listings
nals in their offices for trading interest rates and (23 percent). It trades listed bonds and equities,
35
currency futures, and later stock index futures and unlisted securities, and options. The ISE is now
options. But the banks were for a time discouraged struggling to adjust to changes brought about by
by the Ministry of Finance; but on May 21,1990, the deregulation, automation, and the crash of 1987, but
Ministry of Finance approved the use of GLOBEX it has many advantages as a center for global trading.
terminals. Foreign shares account for about a quarter of all
transactions at the ISE.
Tokyo as a World Center for The ISE is among the world’s largest stock
Securities Trading markets by capitalization, but usually ranks after
Tokyo, New York, NASDAQ, and Osaka. The
Japan is often mentioned as America’s top com-
petitor in securities trading, primarily because the average number of ‘‘bargains’ (trades) per day
Tokyo Stock Exchange rivals the NYSE as the increased by 42 percent from 1983 to 1988, but the
world’s largest market. It is not, however, as average number of shares traded increased by 192
intimationalized as London, nor as accessible to percent (to 408.5 million), reflecting an increase in
foreign traders or investors as either New York or the number of large blocks.
London. Language, culture, and high startup costs London is also the home of the 7-year-old London
are all significant barriers. International Financial Futures Exchange (LIFFE)
SS,’Jap_@eF~cti Deotiow ~~ the ~lz,” The Econo~”st, my 20, 1989, P. 87.
~Sep~ti exc~%es in ei~t citie~bndo~ Be~@ B~ Btitol Dubl@ Glascow, Liverpoo4 and Manchester-were merged in 1973.
The London Stock Exchange was renamed the International Stock Exchange in 1986. Spicer & Oppenheimer, Stock Markets Around the Worki (New
Yoa NY: Job Wiley& Sons, 1988); pp. 207 ff.
3S~Ufis~ s~~ties ~ket~dles ismes of ~mp~es @t~nOt&ted~~ethey wish tOASe SIAk sums of money thanlistingrequires,
wish to release a smaller percentage of total equities, or have too short a trading reeord. There is an over-th~counter market for equity and corporate
bonds.
44 ● Trading Around the Clock: Global Securities Markets and Information Technology

and the center of the Eurobond market, although come forward,’ but instead ‘the degree of oversub-
36 38
neither is part of the ISE. The Eurobond market is scription was awesome. ” The rigorous competi-
an over-the-counter market operated by banks and tion among them contributed to serious adjustment
stockbrokers. Its investors are principally institu- problems. Nevertheless, business volumes increased
tions, and Japanese firms have come to dominate significantly after Big Bang, by some 85 percent for
Eurobond underwriting. customer business and an equal proportion through
‘‘inter-market-maker dealings.
Most major American and Japanese securities
firms are members of the ISE, but none has How the Market Works
succeeded in capturing a significant market share in
U.K. securities. American firms have done well in ISE modeled its new electronic trading support
marketing advisory services, banking services, and system-Stock Exchange Automated Quotations
in mergers and acquisitions. (SEAQ)--after the National Association of Secu-
rities Dealers Automated Quotations system
In October 1986, the British Government deregu- (NASDAQ) in the United States, deliberately reject-
lated the securities market, an event known as “Big ing the specialist system in favor of competing
Bang.” Fixed minimum commission rates were market-makers. Quotations are displayed on the
abolished. Mandated separation of brokering and computer network, and transactions can take place
dealing functions (“single capacity”) was also either by telephone or on the floor. In fact, the floor
abolished; firms could now operate as both brokers 39
was quickly abandoned, and all trading takes place
and dealers, trading for customers and for them- by telephone. The distinction between exchange and
selves. Big Bang opened up the markets. British over-the-counter trading effectively disappeared.
banks were allowed for the first time to become The ISE’s competing market-makers are required to
full-service financial institutions; they can under- try to make continuous markets in the stocks in
write securities and can own brokerage houses. which they deal from 9 a.m. to 5 p.m., but they do not
Restrictions on foreign membership ended. Foreign have the affirmative obligation to trade their inven-
banks can now own up to 100 percent of British tory that NYSE specialists have.
brokerage fins. Most of the leading firms in the ISE
are now corporations, many owned by international After deregulation, commissions paid by institu-
banks and finance houses. Before deregulation, they tional investors dropped to about 0.2 percent of
were all partnerships and the London Stock Ex- transaction value, or moved
40
to a “net price, free of
change was much like a gentlemen’s club. commission” basis. In spite of the halving of
commissions, The Financial Times reported in
The change in market structure was profound; the October 1987 that London stock exchange firms had
Council of the International Stock Exchange says: earned much higher income over the year ‘‘as a
Indeed it was thought that these changes in result of the upsurge in turnover during the past year,
41
working practice were so great that it would not be particularly from small investors. ”
possible to implement them in a staged manner but
Immediately after Big Bang, market-maker firms
they would all have to be implemented in a “big
37 spent millions on computer systems. Big Bang led to
bang. ”
rapid expansion (the number of market-makers on
The ISE Planning Committee “had been worried ISE grew from 5 to 31). Competition was intense.
that insufficient market-making capacity would After the 1987 crash, the drop in trading volume put
—
36Sc~aent ad ~u~t~y for Emobonds we dir~t~ by tie Association of ~ternatio~ Bond ~ers (-D) and proc~s~ either by Ewoclear, in
Brussels, or Cedel in Luxembourg.
37~~ReviW of the c~~al Market in U.K. Equities,’ A Comtdtative D ocument from the Council of the International Stock Exchange ~ereaftercited
as “Council of the ISE”], May 1989.
%bid,, p. 6.
3~tis ~p~mostof the~e. ob~~ersmport~ton~t. 19.20,1987, wh~~eNewYorkexc@ef loor and Chicago pitS were bedlam, the bndon
floor was eerily empty. All action was “upstairs” in the members’ offices and trading rooms.
‘%l’’here is a value-added tax of 15 percent on commissions, a transfer stamp of 0.5 percent on purchases, and a levy offO.80 on trades of over flOCKl
to funce the regulatory fkamework. It was announced in March 1990, that the transfer stamp duty will be eliminated when a new computerized
registration Systeu described later in this chapter, is completed.
dlcfive Wo- ‘<SE Firms Stock Up on Earnings,” Finuncial Times, OCt. 27, 1988, p. 14.
 Chapter 4--America’s Competitors in Global Securities Trading ● 45

the London securities industry into a period of proportion of deals done “at the touch” (i.e., at the
severe cost-cutting and budget-tightening. By March best bid/offer on SEAQ) and no significant decline
1989, it was reported that British brokerage houses in intra-market liquidity, but also no immediate
had lost $2 billion since Big Bang, and had increase in large trades on the exchange--the trend
eliminated thousands of jobs.42 to off-market trading had not reversed.
There have been continuing problems for ISE. A The rule changes made the market less “transpar-
year after the crash, there was evidence that an ent,’ and decreased the flow of information. Last-
increasing amount of business was being done trade prices for large blocks are not at once available.
off-exchange using market prices available on SEAQ. This made it difficult to provide efficient indexes for
The Council of the ISE concluded that ‘the threat of 46
purposes of pricing derivative products. It tended
43
fragmentation was very real.” SEAQ required to create a ‘‘two-tier’ market by encouraging
traders to post on its computer display their bids and market-makers to reserve their best prices for large
offers and the quantity of shares for which they are clients, buying or selling large size blocks at
prepared to deal at that price. For this “transpar- negotiated prices. SEAQ was therefore less reliable
ency” big market-makers paid a price. Smaller, at reflecting true market prices. In fact, however
competing market-makers could “dump” stocks on institutions often continued to deal among them-
them or raid their inventories, thus conveniently selves and stay away from the exchange altogether.
closing out their
44
own positions at the end of each
trading day. When two large market-maker firms Although some critics blame the “automation” of
announced that they were reducing the size of deals the market (meaning the demise of its trading floor
that they would guarantee to transact at their activity) for its problems, others appear to fault the
SEAQ-quoted prices, the ISE dropped its “inter-market- exchange for poorly conceived, poorly planned, and
maker obligation,” the requirement that market- poorly integrated systems. For example, a recent
making45firms deal with one another at the quoted editorial in The Economist said,
prices. A second change in the roles allowed
reporting of large trades to be delayed until the Punished by the inertia brought on by internal
following day, so that traders can buy and sell large dissent, the exchange has never truly found its place
blocks of securities without immediately moving the in the decartelized world that followed the City of
market price. London’s Big Bang in October 1986. . . . Member
firms have lost hundreds of millions of pounds in the
The rationale for these “temporary” changes was fierce competition to trade British equities. The
that they would lead to market-makers displaying efficiency of this screen-driven money-loser has
more realistic sizes on SEAQ. While there might be highlighted, in turn, the awful inefficiency of Lon-
an immediate reduction in inter-market-maker busi- don’s paper-pushing settlement system-as well as
ness and large block trades, it was hoped that some the mish-mash of technical systems that makeup the
firms would provide more competitive prices in market’s creaky infrastructure.47
large trades in the knowledge that they could sell off
The editorial identified two problems with the ISE
large blocks through retail outlets and their positions
related to technology: a) the difficulty of using the
would not be jeopardized by having to deal with
same system to serve both small private clients and
their competitors at these favorable prices.
large institutional investors, and b) the separation of
Subsequent analysis of response to the changes domestic and international markets with separate
indicates that there has been an increase in the rules and trading systems.

42Most American Banks had bought British firms lost money, Chase Manhattan bank ended its equity operation in London in January 1989 with
a $40 million loss. Security Pacific Corp. and Citicorp also lost money.
43Council of ISE, op. cit., footnote 38, p. 7.
44In the United States, NASD found it desirableble to prohibit the use of NASDAQ’ small-order execution system by professional traders, who would
“pick off’ market-makers’ displayed quotes before the market-makers could react to news or rumors affecting the value of stock.
45Under the older market-makers had to trade with clients, agency brokers, and others market-makers at the price they had listed on SEAQ. Under
the new rule market-makers must trade at that price with clients and agency brokers, but not with other market-makers.
46The index usually used to indicate the performance of the ISE, is the Financial Times/Stock Exchange 100 Share Index, or FTSE.
47"Tower or Indecision," The Economist, Feb. 24, 1990.
46 ● Trading Around the Clock: Global Securities Markets and Information Technology

An editorial in the Financial Times, on the other minding and execution facilities especially for the
hand, suggested that the exchange’s central divi- less liquid securities.49
sions and services should be “unbundled’ and
broken apart, made to “stand on their own feet.”48 The report said the role of the exchange was
The editorial said, shrinking, as trading migrated away from the ex-
change to off-board trading, creating the danger of
Nor, given the exchange’s current maze of elec- fragmentation of the central market. The committee
tronic services, many of them in urgent need of emphasized the importance of encouraging retail
overhaul, is it clear why member firms should want clients, and its continued belief that a quote-driven
to be tied to the exchange by the sort of electronic system, rather than an order-driven system50
umbilical cord envisaged by the Elwes group [an ISE ‘‘should be the mechanism for trading EK equities.’
policy committee that is described below]. There were four primary recommendations:

In other words, there appears to be a general ● the introduction of a central limit order facility;
disquiet and dissatisfaction with the ISE, but little ● mandatory preferencing of orders, requiring
consensus on the nature, the causes, or the treatment brokers to direct their orders over telephone or
of the problem. There is a continuing debate about proprietary dealing systems to market-makers
the structure of the exchange. Some members advise displaying the best price (rather than one not
better integration of ISE’s domestic and interna- displaying the best price, but willing to trade at
tional trading (now handled by separate divisions at the best price);
the exchange). Others take an opposite approach, ● an “order exposure” rule for agency crosses
arguing that there should be different procedures, and matching principals, requiring their orders
different technology, and different rules for professional/ to be exposed to a market-maker and take
international trades and for retail/domestic trades, account of existing limit orders,
possibly even a return to the trading floor for the ● requiring market-makers to meet a minimum
latter—an institutionalized two-tier market. A third quote size, with larger trades published as to
school believes that ISE’s major problem is simpler— size immediately and as to price 90 minutes
cut-throat competition among its now 25 market- later.
makers-and can be solved only when some of them
are shaken out. The preferencing recommendation was aimed at
the problem that unless a market-maker is assured of
By early 1990, the exchange was considering a reward (increased order flow) for making the best
reverting to its old rules, restoring the obligations of bid/offer, there is no incentive to make competitive
market-makers for firm bids and offers, dealing with prices and narrow the price spread, especially if by
all customers at displayed quotes, and reporting so doing he allows his competitors to “hit” him at
large trades’ prices immediately. These changes that price. The price-discovery function of the
were recommended by an internal policy subcom- market is threatened, and the central market may
mittee called the Elwes group. The Elwes Report become irrelevant. The report recommended that the
asserted its conclusion that: old rules obligating market-makers to make firm
prices in size for brokers dealing as principals be
. . .within the developing European and International reinstated. The committee also called for efforts to
environment, whilst SEAQ and the Competing improve cost-effectiveness (especially improvement
Market Maker System, with telephone negotiation, of the settlement system).
will remain pre-eminent as a means of transacting
large securities business, there will be a growing Following the release of the Elwes Report, the ISE
acceptance of automatic execution systems for small began restructuring, by eliminating 80 percent of its
business as well as greater demand for efficient limit committees and eliminating 350 jobs, with further
48"Future of the Stock Market" [Lead editiorial], London’s Financial Times, Mar. 2, 1990,p. 18.
49
Its chairman was Nigel Elwes of Warburg Securities. The Report of the Special Committee on Market Development “Review of the Central Market
in UK Equities,” March 1990.
50 In the United States, the National Association of Securities Dealers’ Automated Quotation system (NASDAQ), used by over-the-counter dealers,
is a quote-driven system. The New York Stock Exchange uses “order-driven” systems, meaning that the customer bids and offers, rather than dealers’
quotes, are the basis of matching buyers and sellers to determine a going price.
 Chapter 4--America’s Competitors in Global Securities Trading ● 47

reductions expected. The exchange was to be Individual investors, but not institutions, must settle
reorganized into three divisions, each of which will with their broker whether or not the broker has
have its own managing director, management board, satisfied his part of the settlement. For government
and responsibility for its own computer systems and securities, there is a computerized book-entry trans-
rule-making. The three divisions will be: 1) a fer system, operated by the Bank of England, and
primary markets division to carry out regulatory settlement is normally on the next business day.
responsibilities and provide services for corporate
issuers, 2) a trading markets division to manage Market Regulation
secondary trading, and 3) a settlements division. The The Financial Services Act of 1986 is now the
exchange said that the restructuring was to ‘‘bring basis of Britain’s securities markets regulation. The
focus to its disparate operations and introduce 51a ISE is a registered investment exchange, whose
more commercial environment for its managers. ’ ’ members must belong to a self-regulatory organiza-
The chief executive of the exchange emphasized in tion such as The Securities Association (TSA),
interviews that an immediate task would be the which also oversees the Eurobond market and
“rationalizing” and “re-engineering” of the many corporate finance activities. Both the ISE and TSA
large computer systems serving the various trading come under The Securities and Investment Board,
markets. which authorizes exchanges and self-regulatory
In spite of its problems, SEAQ was given credit organizations, and is itself overseen by the British
for strong performance on October 16, 1989, when Government Department of Trade and Industry. The
European markets fell sharply following the 7 ISE and TSA share responsibilities for investor
percent52drop in the U.S. stock market the previous protection.
Friday. The ISE index value dropped 9 percent but Big Bang represented access deregulation, but not
regained most of that before the end of the day. prudential deregulation. The United Kingdom has
SEAQ continued to quote real-time prices through- more investor protection and related regulation than
out the slide and thereby drew trades from the French 53
other European countries. Because of the Euro-
bourse, which closed, and Frankfort, where the pean Community’s 1992 Directives, aimed at har-
market fell 13 percent. monization of regulation, there may be pressure to
Clearing and Settlement relax these regulations. The British securities indus-
try reportedly shares a consensus that the 1986
Equities and corporate bonds are traded in 2-week Financial Services Act and the resulting level of
“account periods.” All trades done in a given prudential regulation is too burdensome and could
54
account period are scheduled for settlement on the detract from London’s competitiveness.
sixth business day after the end of the account
period. Thus settlement may be as late as 16 business The London International Financial Futures
days or 21 calendar days after the trade. Clearing and Exchange (LIFFE)
settlement costs are high. (See AppendixA: Clearing
LIFFE is not part of the ISE,55 but its presence
and Settlement, for a detailed description.)
adds strength to London’s position in securities
Settlement between brokers and market-makers is trading, as does the presence of the Eurobond
through a central clearing service, TALISMAN, Market. LIFFE was organized in 1982. It trades
owned by the ISE and linked to company registrars. futures contracts on interest rates, currency rates,

51 As reported by Richard Waters, "London SE Sharke-up Cuts 350 Jobs, Most Committees,” in the Financial Times, Mar. 22, p. 1.
52During and after the 1987 crash there were criticisms of ISE performance as there were of other national exchanges. The Exchange rejected proposals
breakers be instituted. There were complaints that some market-makers did not answer their telephones to avoid having to deal; but later
evaluation indicated that much of this could be blamed on lack of telephone line capacity. The Council of ISE reports that: “Institutions in general
acknowledged they had been able to divest in some lines of stock with market makerswhose motivation in entering into bargains could only have been
loyalty to their customers and their duty under the rules of the exchange.. . [T]he market makers were net buyers of securities to the value of L.250
million . . .“ Council of ISE, op. cit., footnote 38, p. 7.
53Sir David Scholey, "Deregulated Competition or Competitive Deregulation?” Institutional Investor, April 1989, PP. 12-13.
54Based on interviews conducted by E. Clemens and others for OTA, op. cit., footnote 1.
55On Apr. 4, 1990 there was an announcement in London that LIFFE and the London Traded Option Market which is part of ISE, would merge;
the form of this merger is not yet clear.
48 ● Trading Around the Clock: Global Securities Markets and Information Technology

and on the stock index. It also trades American-style criticized as too costly by registrars and banks (many
56
options contracts. of whom have vested interests in the paper-based
In its promotional literature, LIFFE stresses the system, since it provides them with fees).
advantages of its position between the Far East and Since the introduction of SEAQ International, as
North America, when “. . the gap between the end much as 25 percent of the total turnover in French
of trading in the Far East and the start of57 trading in and German stocks on a given day has involved at
Chicago can be as much as six hours.” LIFFE is least one counterpart in London. After Sweden, in
developing an electronic trading system, Automated 1986, imposed a trading tax of 1 percent on both
Pit Trading System or APT, that emulates open- sides of a trade, trading volume in shares of 10
outcry trading, and is similar to the AURORA Swedish companies rose temporarily in London, to
59
system developed by the Chicago Board of Trade 5 times the volume on the Stockholm bourse. Now
(see ch. 2). APT is intended to extend trading hours 15 firms make market in the& Swedish shares on
to cover the European trading day, but it will not be SEAQ International.
a 24-hour system and will not be available outside
Nevertheless, the ISE has serious problems. The
the United Kingdom (LIFFE says that the cost of
high-speed communications links is prohibitively competition between London’s markets and those
high) .58 on the continent is strong. How this competition will
develop in the context of the European Commu-
nity’s 1992 initiative is uncertain.
London as a World Center for
Securities Trading
THE EUROPEAN COMMUNITY
London has a long tradition as an international
financial center, and is now the most international- MARKETS
ized of the major securities markets. The liquidity Europe has 39 stock exchanges, as well as some
and depth on the ISE are generally good. Very large uncentralized or over-the-counter markets and infor-
positions are routinely moved at the ‘touch price,” mal, off-exchange trading networks. European stock
or the best buy or sell quote on SEAQ. Until rule markets, apart from London’s, are not now strong
changes in February 1989 (allowing traders to delay competitors to the major market countries. However,
reporting deals over £ 100,000) transparency was one of the major objectives of the Commission of the
considered to be excellent (market-makers had European Community (EC) is to create and strengthen
argued that there was too much transparency). It is a European securities trading arena. Significant
now less transparent, but the 1989 rule changes may progress has been made in harmonizing securities
be reversed. Market surveillance is considered to be laws and regulations--i.e., making them similar and
good. more compatible with the goal of achieving effective
Spreads and commissions have been driven down harmonization by 1992.
by competition and are now very low; however, There are proposals to establish a European
settlement costs are disproportionately high. For 8 equities exchange network on which a “Single
years there have been plans to end the use of share European List” of shares of 300 large European and
certificates by developing a computerized share foreign corporations would be traded, through an
register— ‘‘Transfer and Automated Registration of intermarket trading system, like the Intermarket
Uncertified Stock,’ or TAURUS. It was delayed by Trading System (ITS) in the United States. On the
“Big Bang” and the post-1987 decline, and the other hand, Andrew Hugh Smith, chairman of the
ISE’s efforts to complete the design have been ISE, has proposed that SEAQ-International be the
56 There are two kinds of opions. Conventional or “traditional” options, sometimes cdkxi European-style options, Can be titten on ~Y list~
securily, are for a period of 3 months, are traded over the counter, are not transferable, and must be exercised on a specific &y. “Traded options” or
American-style options am available on speciilc securities, for 3,6, and 9 months, and may be cashed by sale. Both kinds of options can be written in
both the United States and Europe. LIFFE options are American-style options and include options on futures. See LZFFE: An Zmroduction, published
by LIFFE.
5T~id0
5S*CEWOP Forges Ahead in the Technology Race,” Furures and Options, Special Supplement to Euromoney, July 1, 1989, p. 24.
5g’’Taking Stock Home,” The Economist, May 28,1988, p. 102.
 Chapter 4--America’s Competitors in Global Securities Trading ● 49

international marketplace, under a‘ ‘joint initiative’ rities markets, less than 3 percent of households
of the ISE and the German Federation of Stock owned corporate shares in 198062compared to about
Exchanges, based in Frankfort. The Federation of 19 percent the United States, although this in-
European Community Stock Exchanges is planning creased in the 1980s because of privatization of
“le PIPE,” a network to distribute market data from some British nationalized industries. Probably for
and among 12 EC member countries. This could, in this reason, there were no strong customer protection
time, develop into a trading system. regulations in Europe; most European countries did
The EC has a consumer potential that is 1.5 times not mandate full disclosure, prohibit insider trading,
or have securities regulatory agencies. With the
that of the United States and 3 times that of Japan, privatization of state-owned enterprises in several
but the EC countries do not have a strong tradition
countries, bringing with it national policies for
of individual investment in securities. Their ex-
encouraging stock ownership, prudential securities
changes are, however, already ‘‘international. ” A
regulation began to emerge. No comprehensive
number of them have recently been deregulated to
national securities laws were enacted until recently,
give broadened access to their markets, and some under prodding by the Commission of the EC and
have begun ambitious programs of automation. The
following several widely reported stock market
EC must therefore be considered a potential compet-
abuses.
itor in global securities trading.
Of the 12 EC countries, the United Kingdom,
already discussed, has about 35 percent of total The EC’S 1992 Initiative
market capitalization, West Germany has about 13 The Commission of the EC recognized from its
percent, and France nearly 12 percent. West Ger- beginning in 1957 that there should be special
many began, in 1989, a screen-based system (IBIS) benefits from the integration of financial services
for displaying market data on major stocks at eight markets, due to the “unique pivotal role played by
West German exchanges. The Paris bourse is financial services in catalyzing the economy as a
making significant investments in technology in 60an whole." 63 But there was little progress for nearly 30
effort to strengthen and expand its market share. It years. In 1985 the Commission of the EC issued a
64
has, in the past 6 years, created four new markets, White Paper, “Completing the Internal Market,”
for: 1) issues of small companies (the Second an ambitious legislative proposal to achieve a single
Marche), 2) futures contracts (MATIF), 3) options market by the end of 1992. The White Paper
(MONEP), and 4) money market funds (Inter-SVT). proposed 300 directives aimed at regulatory har-
France has also restructured the stock exchange for monization among the member states.65 In 1986,279
broader capitalization, re-privatized its government- White Paper proposals (and a Dec. 31, 1992,
controlled banking system, and lifted all foreign deadline for implementation) were incorporated in
exchange controls. an Amendment to the Treaty of Rome, entitled the
Single European Act. This strengthened the legal
Other European markets are also being strength-
framework for development of a common market.
ened and are undergoing technological and regula-
tory changes. Individual ownership
61
of securities is In these directives the EC did not seek to establish
not widespread in Europe. Even in the United identical regulatory regimes, but instead prescribed
Kingdom, which has the most well-developed secu- basic essential principles with a requirement of

%iscussion with Paris bourse officials, Apr. 2, 1990.

61B. de Cties, GT Gui& to World Equ@ Markets 1988, 101; Euromoney Public, 1988, p. 113.
62’’Into the Provinces,” The Economist, Nov. 12, 1988, p. 131; also SEC, “Internationalization of Securities Markets,” Staff Report to U.S. Senate
Committee on Banking, Housing, and Urban Affairs and House of Representatives Committee on Energy and Commerce, 1987.
Gsceccti, The European chllenge 1992: The Benefits of a Single Market, 1988, P. 37.
~CoWZeting the ~nterna/ Market: white paper from the Commission to the European COunCil, COM (85) 310 m, June 14.1985.
~Und~ the Treaty of Rome, “directives” proposed by the 17-person Commission (2 representatives each from the 5 largest countries and 1
representative each fmm 7 smaller member states) and unanimously accepted by the EC Council of Members, must be implemented by mtional
legislation within each member state within a prescribed period of time. The directives are binding in terms of mult but national legislatures have some
discretion as to ‘‘choice of forma and methds.” l%ieffky, Van Door% and Lowe, “The Single European Market: APractitioner’s Guide to 1992,” 12
B.C. Znt’2 & Comp. L. Rev., 1989, pp. 357, 360. The Single European Act of 1986 amended the Treaty to substitute a“qualifled majority” for the
requirement of unanimity in approval of directives by the Council.
50 ● Trading Around the Clock: Global Securities Markets and Information Technology

mutual recognition. This appears to have made EC companies to raise capital outside of Europe,
acceptance of the proposed directives much easier. reducing the cost of capital.
About half of the 279 directives issued have been
approved by the EC Council of Ministers, meaning There may also be substantial benefits for non-EC
that they are now mandatory. Some of these fins, including those from the United States. They
directives directly create supranational securities will be confronted with stronger competition from
law; others are company law directives that provide European firms expanding to pan-European opera-
the foundation and complement the securities regu- tions, but the directives should also result in a more
lations. Directives adopted or proposed in the field level playing field for U.S. firms, because the
of securities regulation include the Stock Exchange European companies will be subjected to more
Directives enacted prior to the Single European Act stringent prudential regulations (and thus some costs
of 1986, and more diverse proposals dealing with they have not incurred in the past). U.S. firms,
mutual funds, prospectuses, investment services, having met more stringent U.S. regulations, will
and insider trading (box 4-A.) The last three reflect have no serious difficulties or additional costs in
a change in the EC’s approach from seeking complying with EC requirements.
commonality to seeking reciprocity. All of these It appeared for a time that the benefits of the newly
directives rest on the foundation of full disclosure integrated single market would be denied to non-EC
and equivalent protection built by the company law fins. Under Article 58 of the Treaty of Rome, all
67

directives. firms organized within an EC state are considered

“nationals” and accorded regulatory parity, pre-
EC’s company law and securities law directives sumably without regard to the origin of their capital.
seek to create a global common market for securities This would apply to EC-incorporated subsidiaries of
trading by establishing regulatory harmony and a U.S. firms (although not to branches of U.S. firms).
higher level of prudential regulation to make Euro- However, the reciprocity and mutual recognition
pean exchanges more attractive to foreign and provisions of some of the EC securities law direc-
domestic investors. Regulatory harmony should tives, especially the proposed Investment Services
provide European investors with greater opportuni- Directive (see box 4-A), seemed to contradict
ties for portfolio diversification. Increased pruden- Article 50’s ban on discrimination. The EC ‘‘White
tial regulation-safeguards against investor abuse
Paper” also reflected a Commission policy that
and more comprehensive disclosure obligations— concessions should be extracted from non-member
should promote public confidence in both primary 68
states in exchange for the benefits, and this was
and secondary securities markets and should also reiterated in the Cecchini Report, which said:
result in development of a European database on
publicly held corporations. This will facilitate wider In return, EC governments will have the right to
knowledge of European companies among inves- expect appropriate responses from the community’s
tors, analysts, and advisers around the world, and economic partners abroad, notably the U.S. and
could result in stronger demand for EC company Japan. If the fruits of the European home market are
66
securities. It is also hoped that greater liquidity in to be shared internationally, there must also be a fair
the securities markets will promote the use of share-out of the burdens of global economic respon-
sibility, with market opening measures extended
securities to fired acquisitions of other businesses; internationally on a firm basis of reciprocity.
69

and that this will result in economies of scale.

Finally, increased prudential regulation should make This caused non-EC firms to fear that they would
it easier for EC corporate issues to satisfy the not have access to the “single market” and would be
regulations of stricter national authorities (e.g., the at a disadvantage relative to EC firms. The proposed
United States) and thus expand the opportunities for Investment Services Directive, for example, could
66CCCCW op. cit., foomote 64, p.%.
67’’ Coqa~es or f- fom~ ~ accor~m with the law of a member state and having their registeredoffke, ~td aas~tio% or @ciPle
place of business within the Community shall.. . be treated in the same way as national persons who am nationals of member states.”
6sCo@eting thelnternal Mar~t, White p~perfiom the co~”~~on to theE~opean co~il, COM (85) 310 m; pm. 19, the Ody ~CrCXICC tO
non-member states, says: “Moreover, the commercial identity of the community must be considered so that our trading partners WW not be given the
benefit of a wider market without themselves making similar concessions.”
@cecch@ op. cit., footnote 64, pp. XIX-XX.
 Chapter 4--America’s Competitors in Global Securities Trading ● 51

Box 4-A—EC Securities Law Directives

The Admission Directive (No. 79/279), adopted in 1979, is intended to facilitate greater interpenetration of
member states’ securities markets, thereby contributing to establishment of a European Capital market. Together
with two other directivesl, it is intended “to establish. . . a coordinated information policy on securities.” The
directive assumes agreements with non-member states to recognize listing particulars, but the non-member
states’ laws must give equivalent protection to investors, and the non-member state must also provide reciprocity
to the EC member-states. For the United States (and Canada) which have significantly more comprehensive
disclosure requirements, it is unlikely that reciprocal accords can be negotiated in the foreseeable future.
The directive provides minimum requirements for listing, to construct a regulatory floor for equivalent
protection for investors throughout Europe. It contemplates a “subsequent closer alignment of rules,” which
might be accomplished either by further directives strengthening the requirements, or by requiring mutual
recognition which would effectively lower them (any exchange, as a political and economic matter, would be
unable to impose stricter requirements on domestic firms than on firms from other member states).
The Listing Particulars Directive (No. 80/390), adopted in 1980 and sometimes called the Information
Directive, requires extensive disclosure to the general public (some member states had required disclosure only
to regulatory or self-regulatory bodies). It requires an information sheet with common disclosure standards and
a prescribed format, so that for the first time investors and analysts can make comparisons easily on a
multinational
2
basis. This directive influenced the SEC in its development of U.S. disclosure forms for foreign
issuers.
In 1987, the EC Council of Ministers amended the Listing Particulars Directive to include a mutual
recognition directive (once approved in a member state, listing particulars must be recognized by other member
states, and no additional information may be required). This means that a state with more stringent disclosure
requirements is in the position of imposing more disclosure and greater costs on its domestic issuers than foreign
issuers must meet. Almost surely this will mean lowering disclosure requirements to the existing lowest common
denominator.
The Interim Reports Directive (Mp... 82/121) adopted in 1982, requires issuers of equity securities listed on
member-state exchanges to publish certain financial reports at six month intervals. It is intended for investor
protection.
The Public Offer Prospectus Directive (No.89/298), adopted in 1989 after 10 years of controversy, protects
investors by requiring risk-related information from corporations in the form of a prospectus. There are regimes
for both listed and unlisted securities but because the directive was adopted after lengthy negotiations it is riddled
with exemptions that reduce its scope: exemptions for private placements, certain small offerings, minimum
purchase offerings, exchange offers, employee offerings, eurobonds, and euroequities. Eurosecurities were
exempted because the industry repeatedly threatened to trade elsewhere. The disclosure requirements are not as
strict as those in the United States. The directive does however embody the principle that investors throughout
the EC should be protected, and should be provided equivalent protection.
The directive does not require member states to give mutual recognition to issuers from non-member states
even if they comply with its disclosure requirements. It authorizes negotiations based on reciprocity (mutual
recognition and substantial equivalence of regulatory regimes). Since companies in the United States and Canada
will have met higher domestic requirements, they would like to be allowed merely to file a notice of their home
country prospectuses, but reciprocity for EC members with lower disclosure requirements will be a sticking
point.
The Mutual Funds Directive (No. 85/611), adopted in 1985 but amended in 1988, is intended to establish
equivalent protection for investors in collective investment funds throughout the EC and to promote the
circulation of these securities throughout the Community on “a level playing field. ” The provisions relate to
authorization, supervision, structure, activities, and”disclosure obligations. Once a mutual fired is authorized by

1~~~ w-, D&&e No. 80/390, and Interim Reports, Dtitive No. smzl.
2SEC ~l_Noo 3+1635 1 (Nov. 29, 1979); R. H-, “~Re-onof ~ Is~ eand Trading of Securities inthe United States
and-b European Economic Community: A Compariso~” 3 J. Cwnp. Corp. L. & Sec. Reg. 129, 132-22 (1981).

Continued on next page

52 ● Trading Around the Clock: Global Securities Markets and Information Technology

Box 4-A—EC Securities Law Directives--Continued

one member state under these provisions it may be marketed in all other member states with the home state
generally responsible for supervision and control.
The directive does not apply to the closed-end type funds. The fund must offer collective investment in
transferable securities, of capital raised from the public, operating on the principle of risk spreading; and its units
must be repurchased or redeemed at the holder’s request out of the fund’s assets, directly or indirectly. According
to industry spokesmen in the United States, this directive could serve as the basis for international agreements
beyond [EC] boundaries,” facilitating the internationalization of mutual funds. 3
The Proposed Investment Services Directive, newly proposed by the Commission in 1988, would establish
mutual recognition of member states’ authorization and supervision of investment firms. This would mean a
single license for investment firms acting as brokerage agent, dealer, market-maker, portfolio managers,
underwriter, or investment advisor anywhere in the EC. [Because banks and other credit institutions in the EC
also provide investment services, a proposed Second Banking Directive contains similar provisions.] The home
state must determine, before authorization, that the firm has sufficient financial resources to conduct the services
that are to be provided; that the managers are of good reputation and experience; that the controlling shareholders
of the firm are suitable; and that the firm submits a suitable business plan.
The directive requires member states each to promulgate prudential rules requiring investment firms to
maintain sound administrative and accounting procedures and internal controls; to segregate investors’ assets
from the firm’s own accounts; to participate in a general compensation fund to protect investors against the firm's
default or bankruptcy; to provide regular information to the home state supervisory authority; to maintain
adequate records; and to be organized in a way that minimizes conflicts of interest among the firm and its clients.
Under the directive as it now stands, investment firms will continue to be regulated under the capital requirements
and general business rules of the home member state, although EC directives in these two areas maybe developed
later. A state’s authority to regulate local activities of investment firms from other member states is largely
removed by this directive,4 but cooperation between home state and host state in preventing abusive practices
is required by the directive.
Again, the most controversial aspect of this proposed directive is the issue of reciprocity. Investment firms
(and their subsidiaries) from non-member states cannot enjoy the benefits of the directive’s “single license”
unless the fro’s home state provides reciprocal treatment to all EC investment firms. However, there is a
grandfather clause, and foreign firms may rush to incorporate as EC subsidiaries before the adoption and effective
date of the directive. The related proposal for a Second Banking Directive modified the strict reciprocity
requirement to require only “national treatment” (regulatory parity with domestic firms), and it is possible that
this proposed Investment Services directive will also be so amended.
The Insider Trading Directive. First proposed in 1987, revised in 1988, and adopted by the Council of
Ministers on June 19, 1989 (ratification not yet complete), this directive seeks to provide equivalent protection
against insider trading for all EC investors. When it was first proposed in 1987 only three member states
(Denmark, France, United Kingdom) had criminal penalties for insider trading. In the United States, securities
regulators have not rigorously or officially defined insider information,5 but this directive defines it as:
. . . information which is unknown to the public of a specific nature and relating to one or more issuers of transferable
securities, or to one or more transferable securities, which, if it were published, would be likely to have a material
effect on the price of the transferable security or transferable securities in question, 6
This directive is almost certain to be approved7; at present only Belgium, Ireland, Italy, and West Germany
have yet to enact insider trading legislation. However, some observers fear that judges may still treat insider
trading as “a gentlemanly misunderstanding rather than a crime."8

3( ‘EC D~~tive on Mum F~ds May Serve as Basis for Global Agreement, 1~ SaYs,’ 20 Sec. Reg. &L. Rep. (BNA) 1922 (Dec.
2, 1988).
4Each s~te rem limited power to restrict investment fii’ conduct when necessary for “the public goo~” a concept based on
Articles 36 and 56 of the Treaty of Rome.
Ssee sympo~um: Defining Insider Trading, 39 Ala. L. Rev. 337-558 (1988).
6COM (88) 549, 0~. Eur,Comm. (No.C 277) 13 (Oct.27, 1988).
7Nelsom ~~EC M~ms NW /@oral in unit~ p@” Wa/ZSt. Jour~l, June 19, 1989, p. C g.
8~~~i@ Tr~ing in EwOp: A D~t IX@” The Economist, My 20, 1989, p. 86.
 Chapter 4--America’s Competitors in Global Securities Trading ● 53

deny a single EC license to EC-incorporated subsid- For example, the Eurosecurities market-the largest
iaries of U.S. fins; they would not be entitled to European securities market-is exempted from the
home-country control, i.e., authorization and super- Public Offer Prospectus, although a number of
vision by the member-state in which they are problems have arisen with regard to interest and
incorporated unless equivalent treatment is granted currency swaps, distribution methods, and disclo-
by the United States. Because of differences in the sure. 71 In some areas there are as yet no EC
scope and structure of the U.S. regulatory system, directives. Among the number of regulatory areas
this equivalent recognition is politically unlikely. not yet addressed are: rules of fair practice or
After strong protests, an amendment to the directive essential standards to govern the conduct of EC
is being considered which would use the principle of investment firms; real-time publication of quota-
national treatment rather than reciprocity. tions, prices, and trading volume to assure market
transparency. Participants in European securities
It is less likely that the same change will be made
markets will continue to be confronted by 12 sets of
in the reciprocity and mutual recognition provisions
conflicting laws (or absence of law) dealing with
of other directives, including those dealing with
essential areas of regulation in areas not covered by
Admission, Listing Particulars, and Public Offer
EC directives.
Prospectuses (see box 4-A). The U.S. requirements
regarding stock exchange listings and public offer- As yet, EC has no institutional mechanism for
ings, administered by the SEC, are significantly coordination and enforcement of the new regulatory
stricter than EC requirements. They are not inter- system it is creating. Little has been done to
changeable with EC requirements and cannot be harmonize enforcement. The directives provide for
waived by the SEC to accommodate EC issuers, cooperation among authorities, but is likely that in
even though SEC has considerable regulatory flexi- some member states there is strong enforcement and
bility, and has stated that it would favor recognition in others, almost none.
of the disclosure documents of foreign issuers if their
There are two striking points to note about the EC
home state provided reciprocal treatment and the
1992 initiatives in securities trading. First, EC has
disclosures were based on substantially equivalent
70 managed both to improve prudential regulation and
standards.
to increase regulatory harmony-two goals that
The basic problem is that the regulatory regime might have been assumed to be contradictory.
envisioned in EC securities laws directives, adopted Second, it may demonstrate that regulatory harmony
and proposed, provides less protection for investors can be achieved at least on a regional level. This
than is mandated in the United States. They include suggests that harmony could also be achieved
many exceptions and exclusions which greatly among the other OECD states, if the United States
reduce the scope and effectiveness of the directives. plays a strong role in promoting this goal.

70ifSEC policy s~tment on Re@tion of ~t~mtio~ Securities Markets, ” SEC Rel. No. 33-6807, NOV. 14* 1988.
71seepo Stob, Gzo~z ~toc~ ~arkefR@om, 1988, pp. 126-147. me mpid gIO~ of sw~s ~d options hM Id to less review of credit risk and
failure to obtain collateral and a number of defaults have resulted. Prof. ManningWarre@ III, op. cit., footnote 1, makes the point that despite assertions
to the contrary the Eurosecurities market is to a large extent a retail market, and Euroequity offerings especially have large potential for abuse because
of “gaping hopes in member state regulations, ’ unregulated sales pitches and timing pressures.
 Chapter 5
International Clearing and Settlement:
What Happens After the Trade

“Clearing and settlement” is the processing of Where clearinghouses do not exist (e.g., in some
1
transactions on stock, futures, and options markets. European markets), depositories may take on func-
It is what happens after the trade. “Clearing” tions of clearinghouses. Depositories may transfer
confirms the identity and quantity of the financial ownership of stocks and bonds by ‘‘book entry” (a
instrument or contract being bought and sold, the computer entry in the depository’s record books)
transaction price and date, and the identity of the instead of physical delivery of certificates to the
3
buyer and seller. It also sometimes includes the buyer, which saves time and money. There are also
netting of trades, or the offsetting of buy orders and markets in which exchanges perform some of the
sell orders. “Settlement” is the fulfillment, by the clearing and settlement functions (e.g., London’s
parties to the transaction, of the obligations of the International Stock Exchange), and markets in
trade; in equities and bond trades, “settlement” which neither clearinghouses nor depositories exist
means payment to the seller and delivery of the stock (e.g., until very recently, foreign exchange, or
certificate or transferring its ownership to the buyer. “forex,” markets).
Settlement in futures and options takes on different
meanings according to the type of contract.
Trades are processed differently depending on the THE GOALS OF CLEARING
type of financial instrument being traded, the market AND SETTLEMENT
or exchange on which it is traded, and the institu-
tions involved in the processing of the trade (i.e., an Differences in the clearing and settlement process
exchange, a clearinghouse, a depository, or some among countries are often linked to historical,
2
combination). The clearing and settlement mecha- economic, and cultural factors in their laws and
nisms and institutions in the United States, the customs. These differences can expose international
United Kingdom, and Japan are described in the investors to extra risk in some instances. Perceptions
appendix. The differences in countries’ clearing and of the purposes of the clearing and settlement
settlement are important because clearing and settle- process vary widely among countries. In the United
ment systems used for domestic trading are now States and Canada, where public policy supports
being called onto accommodate international partic- broad public access to the markets, the reduction of
ipants. The integrity and efficiency of a nation’s risk, through the clearinghouse as an intermediary,
clearing and settlement systems are important to is a major goal of clearing and settlement. These
both its internal financial and economic stability and policies are reflected in a hierarchy of protections for
its ability to compete with other nations. the clearinghouse, including minimum capital re-
quirements for clearinghouse members.
Many markets have ‘clearinghouses’ that handle
both the clearing process and some of the settlement In many other counties, risk reduction is imposed
process. This is the most common system in the before trading takes place, by controls on who is
United States for exchange-traded financial prod- allowed to participate, or by the participants ‘know-
ucts. Many markets, including the U.S. markets, ing their trading partners,’ and, in equities, by
have “depositories,” that hold stocks and bonds for reducing the time allowed to settle a transition. In
safekeeping on behalf of their owners. these markets, clearinghouse guarantee funds are

lb ~rw~ ~~ c~ptm, Om hm mli~ hmvily on a contractor report by Bankers T~t CO.! “Study of International Clearing and Sett.lemenC”
vols. I-V, Octobex 1989, to which scores of institutions and individuals around the world contributed expert papers and/or served on the Bankers Trust
advisory panel. This report is hereafter referred to as “Bankers Trust report.” OTA has also used the discussions of an expert workshop held at OTA
on Aug. 22, 1989.
% the United States, equities markets clearinghouses reduce risks by netting payments, among their other precautions to reduce cleiuinghouse risk.
These precautions are disparate among nations. Futures markets worldwide are becoming more similar in terms of guarantees for trades.
qD~v~ve instnunents such as futures and options also change ownership or contractual rights Vk book m~.

–55–
56 ● Trading Around the Clock: Global Securities Markets and Information Technology

4
generally small or nonexistent, and settlement is play a key role in the United States and some Asian
seen merely as a delivery function, rather than as a markets; but in many European markets, deposito-
mechanism for risk reduction. ries are more important.
These different views of the purpose of clearing A key role of a clearinghouse is to assist in the
and settlement have become significant as more comparison of trades and sometimes, as in the
investors begin trading in markets other than their United States, also to remove counterpart risk from
domestic markets. U.S. investors, accustomed to the settlement process. Clearinghouses can provide
domestic markets where safeguards are in place, the buyer with a guarantee that he will receive the
may assume that the clearing and settlement of their securities--or other interest-he purchased, and
trades in a foreign market has risks comparable to provide the seller with a guarantee that the payment
s
those in the United States, where there are guaran- will be received.
tees provided by clearing and settlement organiza-
tions. In the United States, the clearinghouse has a
number of working relationships, or interfaces, with
The chief aims of clearing and settlement in the other institutions (figure 5-l). A trade in the United
United States and some other countries are effi- States (as well as in Japan, Canada, and some other
ciency and safety. The faster and more accurately a countries) cannot settle through the central systems
trade can be processed, the sooner the same capital until it has been matched, i.e., buyers’ and sellers’
can be reinvested, and at less cost and risk to records of the trade are compared and reconciled. A
investors. Therefore, as markets become global, one clearinghouse has an interface with a market in
could expect that investment capital will flow which trades are executed and from which the
6
toward markets that are most attractive on a risk- clearinghouse receives information on the trades.
return basis, and that also have efficient and reliable The clearinghouse may receive previously “locked-
clearing and settlement systems. in’ ‘ trades (trades which have already been
The soundness of clearing and settlement systems matched), or it may match the trades itself.
in one nation can also impact other nations. The A second interface is with its clearing members,
failure of a clearing member at a foreign clearing- i.e., the member firms of an exchange or market. A
house could affect a U.S. clearinghouse through the clearing member delivers trade information to the
impact on a common clearing member. To reduce clearinghouse and may hold positions both for itself
the risk of such an occurrence, different countries’ (proprietary positions) and on behalf of its custom-
clearing and settlement systems must be coordinated ers. Other traders in a market, who are not clearing
with each other, for example, by sharing risk members, must clear their trades through a member
information and harmonizing trade settlement dates. of a clearinghouse for that market. A clearinghouse
Both the private sector and Federal regulators have controls the risks of the clearing and settlement
begun to take steps in this direction. It is doubtful process through its relationships with its clearing
that the private sector can achieve the needed members. For example, it may have minimum
changes without national governments taking a capital requirements for clearing members, use
prominent and concerted role. margins or mark-to-market procedures, and require
that its clearing members place collateral in a
HOW CLEARING AND guarantee fund as protection against default by other
SETTLEMENT WORKS clearing members. In the event of the failure of a
clearing member, the clearinghouse may also have
Many kinds of organizations are involved in the ability to assess all other clearing members. It
clearing and settlement. Their functions vary from may also provide its clearing members with a
market to market, and not all of these organizations trade-matching service and notify members about
exist in every country. For instance, clearinghouses the way a trade is to be settled (the settlement date,
4B~eA ~St s~dy, op. cit., footnote 1, P. 142.
SForty.one ~ment of the ~spondents to a Westion in an international survey conducted tis pm of the Btiers T~st s~dy s~ted tit the risk tit
a counterpart to a trade may default, i.e., not pay for or deliver securities, is one of the three most signiilcant risks in settlement domestically. Bankers
Trust study, op. cit., footnote 1, vol. 1, p. 239. Despite such fears, such defaults seldom occur.
%e clearing entity could alternatively receive information about a trade directly from two market participants.
 Chapter 5--International Clearing and Settlement: What Happens After the Trade ● 57

Figure 5-1-interfaces Among Clearing Participants an accounting system for immobilized or demateri-
alized instruments, and/or as a central vault for the
Retail Instltutional
customer customer physical instruments themselves, interfaces with the
banks as custodian. It may also, as custodian, have
7
an interface with the banks for payment.

RISKS FROM DIFFERENCES IN

CLEARING AND SETTLEMENT
MECHANISMS
These differences-the use of guarantee funds,
the time allowed to settle a trade, etc.—in countries’
clearing and settlement systems are a major con-
straint on global trading and may impose risks on
traders and investors. Defaults in a national clearing
and settlement process can propagate through other
SOURCE: Office of Technology Assessment, 1990. national systems, since multinational financial insti-
tutions may be active in several national markets.
Collapse of a major settlement system could endan-
and the way payment and delivery or transfer of ger financial systems in both its own and other
ownership will be accomplished). countries.
A third interface is with clearing and credit banks. Even in day-to-day operations, differences in
The clearinghouse and the banks work together in clearing and settlement systems and in their per-
the payment and collection process, since clearing- formances constrain some kinds of trading. For
houses today do not have direct access to the example, in Japan, settlement in equities and bonds
payment system, e.g., FedWire in the United States. is normally on the third day after a trade (T+3) and
The banks also provide credit to clearing members. in the United States it is normally on the fifth day
In the securities markets-but not typically in (T+5). An investor trading General Motors (GM)
futures and options markets-there is often a fourth stock on both the New York Stock Exchange
interface with the depository. The depository re- (NYSE) and the Tokyo Stock Exchange (TSE)
cords and arranges the legal transfer of ownership of would have trouble perfectly arbitraging his hold-
securities, and holds securities for safekeeping. The ings. If the investor were to buy GM shares on the
clearinghouse instructs the depository on how the NYSE and simultaneously sell them on the TSE,
transaction is to be settled. The depository may act because the U.S. settlement period is 2 days longer,
as an agent, on behalf of the clearinghouse, to the GM shares would be delayed by 2 business days
receive funds to settle the transaction. for the Japanese settlement. If the investor were to
buy GM stock on the TSE and sell GM stock that
In addition to the relationships between clearing- same day on the NYSE, the shares could be available
houses, markets, depositories, and banks, these for the NYSE settlement because that is 2 days later
organizations also have relationships with each than Tokyo’s. The Japan Securities Clearing Corp.
other. Clearing members of a designated market deal (JSCC)--through its link with International Securi-
with the banks to settle with the clearinghouse and ties Clearing Corp. (ISCC) in the United States—
to obtain credit. There is an important relationship holds the U.S. shares at The Depository Trust Co.
between the banks and the depository. When a bank (DTC); therefore instead of physical movement of
acts in a custodial role, e.g., delivering securities and certificates there simply would be a book entry
receiving payments in behalf of its customers, delivery at DTC. The average number of days for
instructions on payment and title transfer are sent to settlement of various financial instruments in differ-
the bank by the customer. The depository, in turn, as ent countries differs widely (figure 5-2). The number

~our depositories in the United States now have links to the Federal Reserve System. These are The Depository Trust Co., the Midwest Securities
Trust Co., the Participants Trust Co, and the Philadelphia Depository Trust Co.
58 ● Trading Around the Clock: Global Securities Markets and Information Technology

Figure 5-2-Settlement Date: T+? with trade matching and confirmation services
provided by the exchanges. Once trades have been
Average number of days
8.0 matched and confirmed, the trade data are sent to the
7.0 depository for settlement. There are variations on
6.0 this model with differing degrees of settlement
5.0 services provided by the depository. The depository
4,0 may offer book-entry transfer of ownership of
3.0 immobilized securities, with limited provisions for
2,0 varying payment methods. Or the depository may
1.0 provide book-entry transfer of dematerialized secu-
0,0
rities and the ability, through direct links to local
Equities Sovereign Corporate Futures Options Other Physical payment systems, to simultaneously and irrevocably
obligations obligations derivatives commodities
- North America = Europe ~ N.E. Asia/ Australia
transfer funds for each settlement. An example is
- Middle East = South America West Germany and its Deutscher Kassenverein
(KV) depository system.9
SOURCE: Bankers Trust Co., “Study of International Clearing and Settle-
ment,” OTA contractor report, October 1989, The third model has not only a stock market and
a central depository, but also a clearinghouse that
of days for settlement varies widely among countries stands between the stock market and depository to
in each geographical region. As a result, harmonized reduce risk. The stock market, along with the
clearing and settlement is needed. clearinghouse, provides trade matching and confir-
Trading in European markets, unlike in the United mation services. A trade is confirmed by the market
States, mostly does not rely only on stock ex- participants and is then passed to the clearinghouse,
8
changes. In Japan, there is as yet no central which substitutes itself as the counterpart to each
depository, but there is a clearing and custody trade. This gives a degree of financial assurance to
system at TSE. Many European countries have the markets since the clearinghouse will honor the
depositories, but their functions vary from country to obligations of a clearing member if necessary. The
country, and are often different from U.S. deposito- clearinghouse then passes the trade information to
ries. the depository for delivery versus payment10 on the
settlement date. An example is the United States
There are three principal models for clearing and equities market.
settlement in the world’s major stock markets. The
first model has no centralized depository or inde- In most European equities markets,ll there are no
pendent clearinghouse beyond the stock exchange. central clearing organizations that assume the role of
The exchanges usually perform as many of the counterpart to every trade or provide other kinds of
clearing and settlement functions as are feasible. mechanisms to ensure the financial integrity of all
These include trade matching, confirmation, and market participants in the clearing and settlement
some type of settlement facility-usually a central phase. Where there is no third-party guarantee
location where market participants can deliver and mechanism for trade settlement, market participants
receive securities and payments. The equities market are forced to choose their counterparties based on
in the United Kingdom is an example. their own credit assessment.

The second model of clearing and settlement is But when a market ceases to be a closed structure
one in which there is a central depository structure, with only a select group of participants who know

% most cases, the majority of trades are among banks, and occur off the exchange. In these off-exchange tmdes, bankers or brokers interface with
the depository, bypassing tie exchange, except possibly for reporting trades,
%ms-Joachim Hoessrich and Heinz-Klaus Ruetzel, “Clearance and Settlement in Germany,” expert paper contributed to OTA contractor report
by Bankers Trust Co., op. cit., footnote 1.
lo~~~~vewv~s paWent*~ (DVP) ~d “=eive Verw paym~t” are te~ which mean that the buyer and the seller =ch sa@ their ~~ement
obligations (to pay and deliver) on the same day. A closely related term is “true DVP,” which means that the buyer and the seller simultaneously make
good on their settlement obligations. An example of true DVP would be a trade settled through a depository, in which the depository simultaneously
transferred the funds and the ownership of the traded f~cial instrument.
Ilwith the excqtion of the Paris Bourse.
 Chapter 5--International Clearing and Settlement: What Happens After the Trade ● 59

each other, the market must implement some stand- Their recommendations are:
ardized processes which can offer a guarantee of
financial integrity. When a national market encour- 1. By 1990, all comparisons of trades between
ages international participation, it must try to ensure direct market participants (i.e., brokers, deal-
the continuing financial integrity of the market. The ers, and other exchange members) should be
current focus in Europe on the standardization or compared within 1 day after a trade is exe-
13
harmonization of clearing, settlement, and deposi- cuted, or “T+l.”
tory systems is in preparation for the common 2. Indirect market participants-institutional in-
market in 1992. (See ch. 4.) The movement toward vestors, or any trading counterparties which
increased coordination of clearing and settlement are not broker/dealers-should be members of
systems is, however, worldwide, stemming from a trade comparison system which achieves
recognition of the increasing internationalization of positive affirmation of trade details.
securities trading. 3. Each country should have an effective and
fully developed central securities depository,
EFFORTS TO REDUCE THE organized and managed to encourage the
DIFFERENCES broadest possible industry participation.
14

Improvement of clearing and settlement for global 4. Each country should study its market volumes
or cross-border trading in equities is being addressed and participation to determine whether a trade
by the Group of Thirty, an independent, non-profit netting system would be beneficial in terms of
organization of businesspersons, bankers, and repre- reducing risk and promoting efficiency.
sentatives of financial institutions from 30 devel- 5. Delivery versus payment should be the method
oped nations. The Group of Thirty addresses multi- for settling all securities transactions.
national financial and economic issues, including
6. Payments associated with the settlement of
Third World debt. The Group’s recommendations
securities transactions and the servicing of
for the world’s securities markets are aimed at
securities portfolios should be made consistent
‘‘maxhizin g the efficiency and reducing the cost of
across all instruments and markets by adopting
clearance and settlement,” and thereby reducing 15
the “same day” convention. (No date has
risk. They set target timetables of 1990 for some
been set for achieving this objective.)
objectives and 1992 for others. In a report released
in 1989,12 the Group concluded that: 7. A “rolling settlement” system 16 should be
adopted by all markets. Final settlement
While the development of a single global clearing should occur on T+3 by 1992. As an interim
facility was not practical, agreement on a set of
target, final settlement should occur on T+5 by
practices and standards that could be embraced by
each of the many markets that makeup the world’s 1990 at the latest, except where it hinders the
securities system was highly desirable, . . . and achievement of T+3 by 1992.
(reached) agreement that the present standards were 8. Securities lending and borrowing should be
not acceptable. encouraged as a method of expediting the

Wroup of Thirty, Clearance and Settlement Systems in the World’s Securities Markets (New York & bndom -h 1989), P. 1.
% the United statos, where there is increasing use of automated trading systems in the stock exchanges and OTC markets,@ _ for
comparison and automatic submission to the clearing system is automatically recorded, Such systems now process two-thirds of NYSE transaction
volume; a large proportion of AMEX volume; and one-third of OTC equity volume. These transactions are pre-matched and reported directly to the
clearing sys~ and have been reported on T+l since the mid-1980s. Both the NYSE and AMEX have on-line trade correction facilities. The rules of
the National Securities Clearing Corp. require that all trade data not already locked in by the automated trading systems must be reported by both trading
counterparties by 2 a.m. on T+l.
1dThe pfi~p~ function of a Cmti securities depository is to immobilize ordematerialize securities. This function permits the processing of
transactions in “book entry” form, which is the basis for achieving efficient and low risk settlement of transactions by transferring ownership from one
account to another by a simple debit or credit on the booka of the depository.
15 Some W~ts use ~~medayt~ ~ds (the PaPent k f~ on ~ sme &y), while others u “next~y” funds for setiement. Adoption of a single
method will improve the eftlcieney of the accounting and payment systems, set the stage for subsequent full automatio~ and facilitate other
improvements such as finality of payment, irrevocability, and bank guarantees.
16~ a ro~~ setflaat ~sta, @ades ~~e on w busin~s &ys of tie w~ which limits the number of ou~~ding (unsettled) trades d redU@S
market exposure to risk. The goal for the long team is same-day settlement.
60 ● Trading Around the Clock: Global Securities Markets and Information Technology

settlement of securities transactions. 17 Exist- some flexibility is needed in tying the cus-
ing regulatory and taxation barriers that inhibit tomer’s time period for payment to the foreign
the practice of lending securities should be settlement date. In March 1990, Regulation T
removed in 1990. was modified to allow the maximum time for
9. Each country should adopt the technical stand- payment to agree with the foreign settlement
ard for securities messages developed by the period, provided that period does not exceed
International organization for Standardization the current U.S. 35-day maximum allowable
(ISO Standards 7775 and 6166).18 period for settling cash (delivery against pay-
ment) transactions.20
Table 5-1 compares nine of the Group of Thirty
recommendations with the present status of clearing ● Changes also have been made in the margining
and settlement procedures in 21 countries, including of foreign securities in U.S. accounts- with
the United States. Major changes will be required by foreign currency-denominated cash and securi-
many countries in order to meet these recommenda- ties.21
tions by 1992.19 In the United States, which is
Implementation plans for the Group’s recommen-
well-positioned relative to other countries, auto-
dations were initiated or considered by its members’
mated systems will facilitate trade matching on the
governments beginning in the spring of 1989. The
trade date and settlement of all trades within 3 days.
U.S. Working Committee of the Group of Thirty met
But, in the United States, there are non-technological
in May 1989 with representatives from exchanges,
barriers to fully achieving the accelerated trade and
the National Association of Securities Dealers
settlement objectives, some of which have been
(NASD), clearing corporations, transfer and deposi-
acted on recently. For example:
tory firms, banks, regulators, and others, to begin
● More stocks must be immobilized in book entry discussing the recommendations. The U.S. Advi-
form; this means that retail customers may have sory, Steering, and Working Committees recon-
to abandon their pattern of receiving certifi- vened a meeting on March 1, 1990 to discuss
cates of ownership for their stock shares. progress on the recommendations on same-day
● The pattern of mailing personal checks to pay funds and shortening the time to settlement. These
for stock purchases will have to change to a and other issues are being accommodated by the
more rapid payment method such as electronic Federal Reserve Board (FRB). David Ruder, then
bank-to-bank transfer of guaranteed funds. SEC Chairman, noted at the 1989 meeting that the
● The Federal Reserve System’s Regulation T, Group’s recommendations are consistent with pub-
which addresses margin-regulations for broker/ lished policy objectives of the Securities and Ex-
dealers, has just been modified. Since the change Commission.22 He also listed other areas that
maximum allowable time for clearing and require attention, such as capital adequacy standards
settlement of trades in the United States is for market participants, information sharing among
different from those of many other countries, clearing entities, and the interaction of derivative

ITS~ties lending ~d borm~ has become an effective toolwed by market participants to satisfy their obligationsto deliver or pay a _
counterpart. In its absence, a failure to deliver can have the consequence of creating a series of additional failed transactions as one party’s failure to
receive becomes the cause of its failure to deliver on its obligations.
1s’l”he 1S0 is a worldwide standards-making body. ISO standard 7775 applies to Securities Message ~s; standard 6166 appfies to rn~tio~
Securities IdentificationNumbex. Currently, no worldwide securities numbaing system is in use. Countries each use their own unique numbering system
for identiiicatio~ rendering them impractical for cross-border transactions.
~% OIOUP of ~ met in ~ndon in mi&Marck 1990, to discuss worldwide progress toward implemmting its nine recommendations. See
aearance and Settlement Systems Status Reports: Spring 1990, Group of Thirty, New York and Umdou which covers the progress of 17 countries.
While the obstacles facing each nation and the efforts required of each to comply with the recommen&tions are disparate, there was general acceptance
of the recommendations.
%ee 55 Fed. Reg. 11158, Mar. 27, 1990. This 35-day period is separate from the 5-day and 3-day settlement periods discussed e~where. It mf~
to the maximum allowable time period for settlement in the event of unavoi&ble delay, e.g., a payment lost in the m@ and it does not apply to reasons
such as a customer being unable or unwiUing to make payment or deliver securities.
zl~id:
22poEV s~aent of tie U.S. s~~tiw ~d fic~e Commission “Re@ation of the ~te~tio~ s~urities ~ets,” November 1988 @
Release No. 33-6807, Nov. 14, 1988; Fed. Reg. 46963, Nov. 21, 1988.
 Chapter 5--International Clearing and Settlement: What Happens After the Trade ● 61

Table 5-l--Group of Thirty: Current Status of International Settlement Recommendations-Equities

Recommendation No. 1 2 3 4 5 6 7 8 9
Institutional Central Rolling
Comparison Comparison Securities Securities Settlement Same-Day Securities
Country on T+1 System Depository Netting DVP on T+5 Funds ISO/lSIM Lending
Australia ........,,. Yes No No No Yes Open No No Yes
Austria . . . . . . . . . . . . Yes No Yes No No Weekly Yes No No
Belgium . . . . . . . . . . . No No Yes No Yes Fortnightly Yes No Yes
Canada . . . . . . . . . . . . Yes Yes Yes Yes Yes T+5 Yes No Yes
Denmark . . . . . . . . . . Yes No No No Yes T+3 Yes No Yes
Finland . . . . . . . . . . . . Yes No No No Yes T+5 No No No
France . . . . . . . . . . . . Yes No Yes No No Monthly Yes No Yes
Germany . . . . . . . . . . Yes No Yes No Yes T+2 Yes No No
Hong Kong . . . . . . . . . Yes No No No Yes T+1 No No Limited
Italy ,...,,.., . . . . . Yes No Yes No Yes Monthly Yes No Limited
Japan . . . . . . . . . . . . . Yes No No Yes Yes T+3 No No Yes
Korea . . . . . . . . . . . . . No No Yes No Yes T+2 No No No
Netherlands . . . . . . . . Yes No Yes Yes Yes T+5 No No Yes
Norway . . . . . . . . . . . Yes No No No Yes T+6 Yes No No
Singapore . . . . . . . . . Yes No No No Yes T+5 No No Yes
Spain . . . . . . . . . . . . . Yes No No No No Weekly No No Limited
Sweden . . . . . . . . . . . Yes No Yes No Yes T+5 No No Yes
Switzerland . . . . . . . . Yes No Yes No Yes T+3 Yes No Yes
Thailand . . . . . . . . . . . Yes No Yes Yes Yes T+4 Yes No No
United Kingdom . . . . . Yes Yes No Yes No Fortnightiy No No Limited
United States . . . . . . . Yes Yes Yes Yes Yes T+5 No No Yes
SOURCE: Updated from A Comparative View: The Group of Thirty’s Recommendations and the Current U.S. National Clearance and Settlement System,
(New York City,NY:MorganStanley& Co.,June 1989),

markets.23 Officials of U.S. regulatory agencies are (IOSCO). 29 Their activities reflect a growing inter-
supportive of the U.S. Committee’s efforts. 24 national concern for making the world’s markets
more stable and compatible, and for reducing
The Group of Thirty is not alone in exploring
avoidable risk.
many of these issues; other international groups
have attempted to develop consensus on some of the The FIBV Task Force includes representatives
issues in clearing, settlement, and payment systems. from the Tokyo Stock Exchange, the International
These organizations include the Federation Interna- Stock Exchange, the VP (Denmark’s depository
tionale des Bourses de Valeurs (FIBV),25 the Bank system), the Amsterdam Stock Exchange, the ISCC
for International Settlement (BIS),26 the Interna- in the United States, Euroclear, CEDEL, the Group
tional Society of Securities Administrators (ISSA), 27 of Thirty, SICOVAM, ISSA, and IOSCO. The FIBV
the European Community (EC), 28 and the Interna- Task Force met in December 1989 to discuss how
tional Organization of Securities Commissioners countries might proceed, and again in March 1990 to

23Davids. Ruder, 4cI&M&s on the (MmIp of Thirty Report on International Clearance and Settlement,” May 15, 1989.

~Commenta by G. Corrig~ President of the Federal Reserve Bank of New York and Commissioner Mary Shapiro, SEC, at tie *h 19N meeting
of the U.S. Committee.
~~e FIBV smdy “Improving hte~tioti Settkmen~’ June 1989, focused on the settlement of cross-national bordertrading. This report endorses
the recommendations of the EEC and Group of Thirty reports and also makes additional recommendations.
~n BIS’S GIOUp of Experts on payment Systems, Committee on Interbank Netting Systems is working on a study of multilateral netting schem=
~For infoMutio~ see ISSA Handbook on Clearing and Settlement in the world’s markets, updated regulmly. An edition covering 28 cowtries and
the Euromarkets was published in May 1990.
~~e EEC’s “study onhnprovements in the settlement of Cross-Border Securities Transactions in the European Community,’ fOCUSd on tie need
for eentmlized depositones.
~Gern~ de -z @em, ~~cl- ~d Setdmen6° rqo~ to the 14th Annual Conference of IOSCO, Venice, September 1989; tie adoption of
a resolution in 1986 that promotes investor protection through surveillance and mutual enfomement assistance; and the establishment of a tecbnical
committee to review rnajorproblems in international securities transactions and working groups to addressspecitlc topics, such as offerrings of securities
on an international basis and multiple listings, the problems with existing memoranda of understanding among markets, and international clearing and
settlement. IOSCO has been studying issues related to capital adequacy for non-bank securities fii and is exploring ideas for risk-based capital
~~U21CY standards.
62 ● Trading Around the Clock: Global Securities Markets and Information Technology

continue its efforts. The FIBV Task Force 30 has tional Settlements has designated a working
agreed to the following steps: group on traded securities, which is currently
exploring issues including the risk-based capi-
promote the development of links between
tal standard and explicit treatment of position
national markets;
risk for banks.
assist one another by exchanging plans and ● The SEC and U.K. regulators have entered into
procedures for implementation (a Practice which
a bilateral agreement under which the U.K.
has already begun);
regulators will waive their capital adequacy
standardize communications message formats,
requirements with respect to particular U.S.
terminology, and legal agreements;3l and
broker/dealers that have branches in the United
assist each other in understanding the ramifica- Kingdom, if the SEC provides certain informa-
tions of their individual decisions on interna- tion to their U.K. counterparts.35 The SEC is
tional trading.32 exploring bilateral agreements on the subject of
The Commission of the EC commissioned a sharing information for enforcement purposes
report 33 with recommendations that to date have not and, through IOSCO, is looking into the
gained wide support among EC countries. It is feasibility of multilateral agreements toward
unlikely that the EC will adopt the report’s recom- this end.
mendations soon, but will await the results of other
Although several of these groups have some
international efforts. The report’s recommendations members in common, each of the efforts is proceed-
focused on the need for central depositories in
ing independently,36 and there are several points of
Europe, not on clearinghouses; therefore, many of
agreement among the most prominent groups (table
the recommendations do not apply to the United 5-2). These proposals and efforts are a starting point
States. for improvement, but some of these will require
ISSA, whose officers are directors of six major action by the national gov ernments. 37
international banks, produces handbooks on clearing
The reforms suggested by the Group of Thirty and
and settlement in world markets to promote progress
other organizations are being taken seriously in the
in securities administration. Key issues in clearing
United States. Several recent reforms have been
and settlement were identified in an ISSA confer-
made in the U.S. equities markets, many of which
ence in 1989.34
predate the recommendations of the Group of Thirty.
Among other efforts to improve elements of the These include:38
clearing and settlement process are:
. Trade Processing
. The Committee on Banking Regulations and —The NYSE in 1988, began developing an
Supervisory Practices of the Bank for Interna- on-line trade reconciliation system which

~ormation on the FIBV Task Force is based on a December1989, interview with Mary Ann CaUahruq ISCC, who attended the last Task Fome
meeting.
31A5 in many Other areas where international harmonization or sm~ “ tion is in its infancy, there area surprisingly large number of specialized
terms used in different ways for comparable functions by various countries, a situation which hinders cross-national border trading.
3ZAS an e~ple of the latter, the Hong Kong Stock Exchange has already decided to implement a 2-day settlement period. Such a short period ~
pose problems for settlement of cross-national border trades.
ssJorg-Rol~d Kessler, ‘Study on Improvements in the Settlement of Cross-Border Securities Transactions inthe Euro~~onomic COIUIXIMtY,’
1989.
MISSA Sppsi- 4‘Glob~ %xrities Investments: Processing Issues and Solutions, ’ SwitzerlancL my 1989.
Ssundm ~ ag=mm~ tie SEC wi~ now u~+ re@ators if it becomes awme that a pfic~~ broker-d~er’s fincid or opellitioti CC)Il&tkXl
is impaired, and U.K. regulators will provide reciprocal services.
~~e fact that some of the same people, including regulators, participate in a number of these groups protides a m~ of coordination
internationally,
sTSee, for ex~ple, GOUP of ~, “u.S. Working tioup Report on Compressing the Settlement PeriocL” NOV. 22 1989; md B*em Tmst CO.+
op. cit., footnote 1, p. 206.
38For ~ ev~ution of Progess on fiplemenfig tie r~mm&tiom of tie president’s worm Group on F~ci~ Mkets rek~ to c1*
and settlemen~ see U.S. Congress, General Accounting Offke, Clearance and Settlement Reform: The Stock, Options, and Futures Markets Are Still
at Risk, GAO/GGD-90-33 (Gaithersburg, MD: April 1990).
 Chapter International Clearing and Settlement: What Happens After the Trade ● 63

Table 5-2—Recommendations From Major ● Risk Management

International Studies —Information sharing of the financial posi-
Report tions of participants’ who are active in
multiple markets is being worked on by the
Aspect of operation ISSA EEC G-30 FIBV
— Securities Clearing Group (SCG), which
Two-sided trade matching . . . . . . . . . — Yes Yes
One-sided trade comparison . . . . . . . — — Yes Yes represents U.S. clearing organizations serv-
National central securities ing equity and equity options markets. This
depository a . . . . . . . . . . . . . . . . . . . Yes Yes Yes Yes group is working to develop a system for
b
Evaluate securities netting . . . . . . . . . Yes Yesc Yes Yes
Delivery versus payment . . . . . . . . . . Yes Yes Yes Yes sharing settlement, margin, and clearing
Rolling settlement . . . . . . . . . . . . . . . Yes Yes Yes Yes fired at-risk exposure information about joint
d
Same-day funds . . . . . . . . . . . . . . . . . Yes Yese Yes Yes members. 39 An earlier, continuing effort in
Use of ISO standards for message
formatting . . . . . . . . . . . . . . . . . . . . Yes Yes Yes Yes the futures industry (the BOTCC’s system)
Lending for settlement . . . . . . . . . . . . Yesf Yes Yes Yes to share pay-collect information is being
Cross-border Central Securities expanded to include options issued by the
Depositories should be linked . . . . Yes Yes — Yes
Securities should be immobilized in Options Clearing Corp. (OCC). (There is still
country of issuer . . . . . . . . . . . . . . . Yes Yes — Yes some concern by the OCC about the confidenti-
aDepositories for securities are already widely used in the United StateS. ality and perishability of data, and uninten-
blncluded as part of the risk reduction/resolution recommendation in the
report.
tional competitive advantage.) In the United
clncluded as part of the risk reduction/resolution recommendation in this States, the trend is toward interfacing exist-
dincluded as a subset of the dellvery versus payment recommendation of ing centralized risk information systems for
this report. derivative markets with the emerging cen-
elncluded as part of the currency accounting recommendation of this report.
flncluded as part of the risk reduction/resolution recommendation in this tralized risk information system for equities
report. markets.
SOURCE: Bankers Trust Co. adapted from Federation International des
Bourses de Valeurs (FIBV) document.
—The NSCC has proposed to the SEC changes
in its criteria for assessing risk-based contribu-
tions to guarantee funds from clearinghouse
has evolved into its current Overnight Com- members, and to make earlier calls for
parison System. additional contributions. Due to a recent
change, now only 70 percent of an NSCC
—The National Securities Clearing Corp. (NSCC)
clearing member’s collateral may be in the
implemented earlier input and output time form of letters of credit. In addition, the
frames to facilitate trade matching on the day
NSCC’s Board of Directors has approved,
after the trade (T+l).
and NSCC has obtained, a bank line of credit
—The NSCC is participating as part of the of $200 million.40
Group of Thirty, U.S. Working Committee, —The SEC proposed an increase in capital
in the evaluation of ways to shorten the adequacy requirements of full-service broker/
timetable for settling equities trades to T+3 dealers from the present $100,000 to $250,000
(from the current T+5). to be phased-in by January 1994. 41
—The NASD has implemented a Trade Accep- —The OCC initiated an intra-day margin call
tance Reconciliation System (TARS) for procedure directly to the clearing member’s
same day or next day automated reconcilia- clearing bank, in contrast with the earlier
tion of unmatched trades and is currently procedure of contacting the member and
phasing in its Automated Confirmation Trans- allowing 1 hour for payment.
action (ACT) system for same day compari- —The OCC has increased the initial net capital
son of all trades not already locked in requirement upon application for clearing
through automated execution systems. member status from $150,000 to $1 million.

4oData from Robert Woldow, Executive Vice President and General Counse~ NSCC, March 1990.
41 SEC Rel~e No. 3~2724g, “MpOsed Rukmakhg on Broker-Dealer Net Capital Requirements,” S28-89, Sept. 15, 1989.
64 ● Trading Around the Clock: Global Securities Markets and Information Technology

UNRESOLVED PROBLEMS dictions are satisfactory;

what improvements are needed, in cooperation
In futures markets differences exist both domesti- with other regulators, to strengthen the contri-
cally and internationally. There is some commonal- bution of their markets toward improving the
ity, however, for financial safeguards in U.S. domes- overall financial integrity of the national finan-
tic futures markets. These safeguards include: origi- cial system; and
nal margins for clearing members based on trades what improvements are needed, in cooperation
carried for their customers and their proprietary with authorities in other countries, to strengthen
accounts; daily and intra-day marking-to-market and the financial integrity of futures, options, and
calling of variation margins; initial and maintenance equities markets internationally, and to contrib-
margins for customers; clearinghouses serving as ute to an overall strengthening of the interna-
guarantors of trades; posting deposits by clearing tional financial system.
members, which are callable by the clearinghouse;
systems for monitoring the risk positions of both There is also the question of how to supervise
clearing members and customers; and large trader groups that invest in a variety of financial instru-
reporting. ments and markets internationally. Current systems
are not able to achieve this, although they make
Clearinghouses have tended to structure them-
some efforts to provide a picture of the overall
selves as fortresses, able to contain significant
financial risk of such participants.
damage to their systems from internal causes with a
hierarchy of safeguards or “firebreaks.” Assump- Concerns about whether or not futures margins
tions underlying the adequacy of firebreaks are levels in the United States are set appropriately have
increasingly less valid because of the growing been addressed by the President’s Working Group
linkages between futures, equities, and options on Financial Markets, which concluded that they are
markets; these linkages have become international.42 set in a prudential manner and recommended no
changes in margin-setting systems.44 45 Neverthe-
Exogenous forces could prove overwhelming,
less, Federal Reserve Board Chairman Alan Green-
e.g., either a general crisis in the financial markets,
span noted his concern that futures margins that are
or a failure of one or more large banks or broker/
set too low tend to be raised during periods of market
dealers for reasons unrelated to the financial markets
turmoil, reducing liquidity when it is most needed.%
themselves. In such a case the ability of a clearing-
house to assess its members, after it exhausted all of Shortening the interval between trade execution
its margin and guarantee funds, would be ineffec- and the collection of margins could be a benefit, by
tive. 43 reducing the exposure of clearing members before
the clearinghouse’s payment guarantee is effected,
Some key questions for market regulators are:
and the exposure of the clearinghouse in the interval
. whether the financial standards at individual between the provision of the guarantee and collec-
markets and clearinghouses within their juris- tion of margin payment.

42~c~el H+tt, s~Or Adv&r, F~ce ~d ~dus~ Departmen$ B@ of ~l~d, “F~ci~ ~tegrity of Futures Markets,” pleSented at the
Futures and Options Market Regulators Symposium in Burgenstoc~ Switzerland, September 1989.
A3Rog~ Rum, ~ef ~ative offl~er, BOT’CC, be~eves tit in a g~~~ f=~ ~ket ~sis sce~o, here cotid & a complete WOnOdC
collapse, ortheFRB, aslenderof Iastresort and provider of liquidity to the financial syst~ will act to stabilize market conditions. In the second scenario,
the FRB would probably rescue a large bank and the government might have no choice but to do the same for a large non-bank brokerdealer. Expert
paper contributed to OTA contractor study by Bankers Trust Co, op. cit., footnote 1.
Although the recent experience in the liquidation of Drexel, B- Lambert casts doubt on the concept of afmbeing too large for thegovexnrnent
to allow to fr@ and provides credibility to some alternative criteria for a government rescue actio~ such as the broader impact of such a failure.
~~terim Report of the President’s Work@ Group on FiIEUE id A&rkets, May 1988, p. 5: “.. current minimum margin requirements provide an
adequate level of protection to the fmcial system. . .“ More recently, however, the Administration appears to have taken a different view, namely,
tbatfhturesmargins areset too low, and that a single Federal agency should have day-to-day oversight “toharmonizemargins between futures and stocks
to protect the public.” Testimony of Robert R. Glauber, UnderSecretary of the Treasury for P“mance, before the Senate Committee on Agriculture,
Nutritio~,and Fores~, May 8, 1990.
*There is* the view that bightZ illitiill _ with less frequent reviews might be safer than today’s lower margins and more fkequent reviews.
Hewitt, op. cit., footnote 41.
46~ testimony of Alan Greensp~ ~ Federal Reserve Board, before the Senate Committee on Banking, Housing and UrbanAHairs, Mar.
29, 1990. He said: “I was shocked” about the margin setting behavior in the futures markets in October 1989.
 Chapter 5--International Clearing and Settlement: What Happens After the Trade ● 65

There are advantages for firms that are members . technology;

of several exchanges in having their positions at . standardization and harmonization;
each exchange confirmed, registered, and guaran- ● shortening the time to settlement and providing

teed at the same time. Simultaneous transfers of same-day funds.

funds could be made by their settlement banks in
payment of margins. The advantages would be far Risks Associated With Default
greater (but achievement more difficult), ,if settle-
ments were synchronized between financial futures Investors need to be made aware of the differences
and options markets. The synchronization of settle- in the amount of protection provided by various
ment timetables across time zones is theoretically foreign markets. For example, there are no interna-
possible once settlement periods of less than a full tional standards for guarantees (by clearing organi-
day are achieved. zations, banks, and others)--either for the protection
of investors or to prevent the collapse of financial
Is a member-owned clearinghouse that is backed institutions.
by the assets of its owners safer than an independent
clearinghouse, such as London’s International Com- In the United States, the Securities Investor
modities Clearing House, that is owned and backed Protection Corp. (SIPC)48 provides a level of protec-
by strongly financed shareholders, i.e., banks? This tion to market users in equities, bonds, and equity-
depends on whether the guarantee is more robust if related options markets. The protections afforded by
backed by a special reserve fund, the assets of its exchanges and clearinghouses in futures markets to
member-owners, external credit lines, guarantees or market users vary and are extended mainly to
insurance arrangements, or by a combination of clearing members of the exchange’s clearinghouse.49
these.47 This also depends on the liquidity of the Insurance can never completely cover all losses.
assets involved. Some failures in securities markets are resolved in
the United States through bankruptcy proceedings
Large risk exposures to single customers have under the Federal Bankruptcy Code. The Bank-
been a source of financial problems in futures ruptcy Code relies largely on State laws to determine
markets in some countries (but not in the United rights to property. These may include State commer-
States). In the United States, the Commodity Futures cial law that often relies on the Uniform Commercial
Trading Commission (CFTC) has had a large-trader Code (UCC).50 The UCC is being reexamined to
reporting process since before the October 1987 reflect the realities of today’s marketplace, espe-
market break. Similar information-sharing proce- cially where it applies to third-parties holding
dures are needed to monitor exposure in interna- securities. Laws dealing with bank liquidation also
tional futures markets. need to be updated and made more consistent with
other bankruptcy laws.51 In nonregulated markets,
such as foreign exchange, there is little investor
POLICY ISSUES protection.
Six areas of major concerns need to be addressed:
The SIPC in the United States, the Canadian
● risks associated with default; National Contingency Fund, or the United King-
. risks associated with the payment process; dom’s Securities Investment Board contingency
. information sharing; fund are possible models for international markets

gT~ the United Stites, ~~r the 1987 crash the size of guarantee funds was increased and greater cash deposits were rtX@Xi in place of tink letters
of credit, and the size of letters of credit outstanding with futures clearinghouses ffom any single bank was limited.
4SSIPC insmes an investor’s acco~ts Up to $xI0,000 for securities and cash against certain types of loss, e.g., the default of a broker. ‘l’’his includ~
a maximum of $100,000 in cash per account. Securities Investor Protection Act, 1970.
g~t Shouldh noted that customers’ losses stemming from Futures Coremission Merchants’ insolvencies have been rare. Insolvency losses horn 1938
to 1985 amounted to less than $lOmillion. Nationzd Futures Association study CwtowrkcountProrection, Nov. 20, 1986, p. 13. The basic protection
is the statutory requirement that 100 percent of customer funds be segregated. Commodities Exchange Act, sec. 4d(2). Also, customers have first priority
in commodity brokers insolvencies under the Federal Bankruptcy Code and CFTC bankruptcy regulations.
50’l”he UCC is accepted on a State-by-State basis and amendments to it would still leave open the possibility of non-uniform treatment by the various
States. The American Bar Association has a current project that is seeking improvements to this area.
51~ ~fia ties, Cmtomem were inched t. keep ~ss=sion of their s~~ties ~rtificat~. Mom r~ntiy, my buyers of securities tend to kive
their certMcates on deposit with third-parties, e.g., banks, brokers, depositories.
66 ● Trading Around the Clock: Global Securities Markets and Information Technology

which do not now have any protection for investors. payment, the less is the clearinghouse risk. Time-
Canada uses private insurance, while the United tables for finality of payment of settlement vary
States and the United Kingdom use government within the United States and internationally.55 The
guarantees. These are topics that warrant the atten- private sector and the regulators must harmonize
tion of governments and the private sector. disparate systems, at a minimum to provide same-
day finality of payment.
Risks Associated With the Payment Process
Netting of payments reduces the stress on pay-
There have been recent innovations in the way ment systems by requiring market participants to
payments are made for transactions. Increased vol- pay (and receive) only the difference between the
ume of trading has heightened the stress on pay- amounts each owes and is owed by others. This
ments systems. Issues that have arisen concerning increases liquidity for market participants and re-
payment risk include: delayed or inadequate bank duces the risk that a market participant will default
credit, timetables for finality of settlement, and on either payment or delivery of securities. There is
netting procedures. Problems may arise with 24- consensus among experts that legally binding net-
hour trading systems, for example, margin calls ting should be expanded, for payments and for
when banks are closed. securities delivery obligations. This issue must be
Bank officials need to be more familiar with the addressed internationally by the private sector and
processes and risks of clearing and settlement to regulatory authorities.
make better and more expedient credit decisions,
particularly in times of severe market volatility. At Information Sharing
such times, the lack of adequate information on
which to base credit decisions may force some banks
In most kinds of financial transactions, a lender
(e.g., a bank) will have access to information about
to restrict credit earlier than necessary.52 This could
the past creditworthiness and the current financial
exacerbate a downward market spiral. Knowledge
risks of a potential borrower. However, there is no
about the riskiness of various financial instruments
central source of risk information for financial
and trading techniques are important for lenders.
markets participants in spite of the large amounts of
Educational efforts of this kind are receiving some
money often involved. Some organizations in the
attention by the private sector, but more is probably
clearing and settlement industry have arrangements
needed.
among themselves for sharing risk information
The timetable for finality of settlement is a about market participants either formally or infor-
problem. Some payment systems, such as the FRB’s mally. Such arrangements are limited in scope, and
FedWire, offer immediate finality of settlement; creditors are at a disadvantage because increasingly
other payment systems offer “end of the day” market participants trade on more than one ex-
finality of settlement,53 and others are on later change, in more than one market, and in the markets
timetables. 54 The shorter the time to finality of of more than one country.56 57

sz~e Clearing Orgtitiom and Banking Roundtable is addressing methods to assure that clearing mernbcm have adequate credit dtig ties of
market turmoil. Them are currently concerns for the privacy and contldentiality of clearing members tbat hinder the attractiveness of the concept of a
single center for complete information on all members’ positions in all markets. This organiza tion was started by the CME and BOTCC to begin a dialog
among futures and equity-related clearing organizations, their Federal regulators, and clearing banks.
ss~e~~fii~of settl~entis avai~bleonly in the United States (through FedWire) andin Switzerland. The CHIPS system in theunittd Smta,
the CHAPS system in the United Kingdom and the SAGI’ITAIRE system in France are examples of payment systems which offer end-of-day finality
of settlement.
~s~ B~ms Trust repo~ op. cit., footnote 1, vol. 1, p. 149.
SsResWndmts t. a smey conducted by B~~s Trust Co. iden~~ the use of “~~&y ~ds” ~d ‘ ‘using el~troflic fids Emfa inst~d Of
checks” as the major improvements that they would like to see in the way that payment systems work in cl earing and settlement. In answer to another
quesfionon what changes or improvements respondents would like to see in the clearing and/or settlement process, the two most frequent responses were
“standardization of settlement times internationally” and “centralized depositories in other countries. ”
56About 39 ~rcat of tie North ~eric~ respondents to tie s~~ conduct~ by B~ers Tmst stat~ tit they trade in markets k mOl_e dWl One
country. Bankers Trust study, op. cit., footnote 1, vol. 1, p. 235.
57while u-se cl~@ouses oWrate ~ sfigle ~kets, 20 ~rcmt of their me~r ~ tie in mo~ tin one market. General ACCOllI@ offiCe,
op. cit., footnote 37, p. 4.
 Chapter5--International Clearing and Settlement: What Happens After the Trade ● 67

There is a general consensus that risk information the transfer of equity ownership through electronic
should be shared, 58 but there is fear that risk book entries. Others restrict the importation of
information might give an advantage to potential automation and communication equipment and re-
competitors. Increased automation could facilitate quire domestic sources. These are areas where it will
information sharing. This could lead to the develop- be necessary for governments as well as the private
ment of a common format for reporting and distrib- sector to make decisions about appropriate actions.
uting risk information, and standards for the timely
While clearinghouses have made significant
delivery of risk information. Standards also are
strides in upgrading technological levels, the bene-
needed for evaluation of different risks in different
fits of these upgrades can be diluted if all clearing
markets: for example, a given dollar amount of
members are not sufficiently advanced technologi-
financial obligations in one market may not equal
cally to respond to new requirements of the clearing-
the risk of a like financial obligation in another
house for which the technology was intended. In
market.
some cases, the weakest technological link may
Bilateral links for sharing information have been limit the responsiveness of the system during
developing among clearinghouses, depositories, and operational stress, particularly under high-volume
regulators in various countries; these have set the conditions. These are areas where, inmost countries,
stage for more global sharing of risk information. the private sector will have to take the initiative to
However, there are often legal restrictions on the bring about needed changes.
flow of information across national borders.59 It is an
issue that requires government and private sector Standardization and Harmonization
attention if it is to be resolved satisfactorily.
Uniform codes of operation, or standards, for both
60 the process61 and the infrastructure62 of clearing and
Inadequate Technology
settlement would make it easier to link the world’s
Technology may or may not have a significant clearinghouses and depositories. There is strong
impact on clearing and settlement at low trading motivation by regulators, the Self-Regulatory Or-
volume; but during high volume, technology is often ganizations (SROs), and the private sector, for
a key to efficient clearing and settlement. Most of the standardization to meet the demands resulting from
U.S. clearing and settlement system is technologi- globalization of world markets. But progress in this
cally advanced, although there are some areas area is likely to be slow because of the complexity
needing improvement. However, the clearing and of effecting change. The United States (with respect
settlement industry worldwide (including many to equities and options markets) and a few other
brokerage firms and banks) are operating at an countries have standardized their domestic systems
inadequate level of technology to meet the increas- both in the process and the infrastructure, although
ing demands of the markets. there are notable differences among them.
Cultural, legal, regulatory and economic factors Operating hours and daily schedules for banks and
sometimes work as barriers to increasing the level of financial markets are not uniform, either domesti-
automation. For example, some countries prohibit cally nor internationally. Banks, including the cen-

5S~e B~rs Trust -~y of fit~tio~ cleouses ~d exc~ges r~ived 18 out of 20 respo~s favo~ the shar@ of risk pOSitiOn
information “as useful or absolutely essential” among clearing and settlement organizations for the purpose of reducing clearing members’ exposure
rislm Bankers Trust study, op. cit., footnote 1, vol. 1, p. 231.
5!)As ~-lw, Bel@~ ~d swi~~d ~ve s~ct privacy ~~s which ~trict the m of a client’s ~o~tio~ Such as trade details, witb third
parties. IBu “Study of Clearance and Settlement for the U.S. Congress-OT&” Aug. 1, 1989, pp. 7, 39. This report is incorporated in the O’E4
contractor report, Bankers Trust Co., op. cit, footnote 1.
@This section is based on “IBM Study of Clearance and Settlement for the U.S. Congress-01%’ Aug. 1, 1989, Ibid. The IBM study is based’on
opinions of participating experts from the world’s major exchanges and clearing organizations.
Gltt~Wess$* ~fm t. owmtio~ ~tiom filu~ ~de ~tc~, the number of days to clear a tmde, number of days to setfle a ~de~ ‘e ‘e
of a depository for holding equities and keeping records of ownership, the use of a recognized numbering system for identifying financial instruments,
fo~ta for data ~missio~ and the method of payment.
Gzt{-ticwe,t ~fem t. ~ of ~ ~ny nonor~o~ f-es n=- to -e ~ cl- ~d ~~eme~ proc~s work b a COllsiStent d
stable manner. These include the method of regulatio% mechanisms to protect the clearinghouse against the financial failure of a clearing member, a
reserve of funda to protect customers of a failing broker or futures commission mercmt, banlmptcy laws to adjudicate the disposition of customer assets
if a broker fails, credit processes at banks, clearinghouse trade guarantees, capital adequacy guidelines, and bilateral tax treaties among nations.
68 ● Trading Around the Clock: Global Securities Markets and Information Technology

tral bank, maybe closed even if financial markets are Shortening the Time to Settlement and
open. 63 This disparity becomes increasingly impor-
Providing Same-Day Funds
tant as market participants invest in more than one
country. The FRB, SEC, CFTC, and the Treasury The need for standardization, or harmonization, of
Department must first face this issue in the United clearing and settlement is manifest by the various
States. international standards-setting efforts already under-
way.67 One example of the need for standardization
Many investors in the world’s equity markets deal is shown by the differences among countries in the
with global custodians for clearing and settlement.64 number of days to settle a trade for different financial
Therefore, no matter how significant the improve- instruments. This is a case in which the private sector
ments in the clearing and settlement process, the likely will require the support of national govern-
gains in efficiency can be diluted unless parallel ments to establish minimum standards for harmoniz-
improvements are made by global custodians. 65 ing international clearing and settlement. The United
Currently, there are no standards that define a global States, for example, must shorten the settlement
custodian, 66 yet these are important to achieving period for equities. This most likely would require
smooth-working global markets. This needs to be immobilization of securities in a depository, and the
addressed at the international level by both private public would also benefit from a change to same-day
sector and government regulators. funds.68
Markets around the world compete to be agents The elimination of physical delivery of certifi-
for capital transfer, and have made innovations to cates is the key to automating the clearance and
improve their competitive positions. Before and settlement systems. This has been achieved legisla-
after the October 1987 crash, the private and public tively in France, where certificates are dematerial-
sector have taken steps to reduce systemic market ized (i.e., paper certificates are eliminated and
risks. These risk-reduction efforts include increased computer-based records are substituted), and in
co-operation among the world’s regulatory bodies. Germany, Switzerland, Euroclear, and CEDEL (the
But efforts to improve clearing and settlement international clearing and settlement firm) by using
systems-domestically and particularly in some nominee custodians to centrally transfer ownership
foreign countries-likely will fall short unless by book-entry. The United Kingdom has established
change occurs in: 1) process, and 2) the infrastruc- a depository nominee (SEPON) for the book-entry
ture. Many gaps in the infrastructure (methods of transfer of ownership between market-makers. The
regulation, taxation, customer protection) exist, but system will be extended to other exchange members
have not yet received adequate attention. and some institutional investors,’ and the United
Kingdom has plans to implement a book-entry
Effective reforms in clearing and settlement will
transfer approach for all transactions. Japan and
have to be undertaken on an international scale. The
Hong Kong have enacted legislation that requires
private and public sectors in the United States can
automated book-entry clearance and settlement sys-
act as leaders in the evolution of improvements in
tems.
the domestic clearing and settlement industry, but
they face serious constraints in achieving worldwide The U.S. Working Committee of the Group of
improvements unless their efforts coincide with Thirty concluded that the greatest deterrent to
those of other countries. Both private sector and achieving shorter settlement at the retail level, or the
government actions are required. ‘‘customer-side, ‘‘ is the physical delivery of certifi-

63~~ isme, fm ~ u~~ s~te~, _ fi~ ~ ~ Feb. 8, 1~ meting of the B- ~d CIXOUW Round@ble, wherc members _ to
hold further discussions. The problem is far more complicated internationally and far from being resolved.
64A ~lob~ ~~~ is a * tit holds s~ties ~ oh financial instruments in multiple markets on bdlidf of in~~tio~ investo~.
fiFor mm on this Subjech see Bankers Tmst Co., op. cit., footnote 1,vO1. 1, p. 174.
% International Society of Securities Administrators may begin to develop standards for global custodians in 1990.
67B~=TW6 fiits -Cy of cl- ~ ~~=entp~~pmts worldwide, *MI tie qu~tio~ Which Critical c1- W settlement probl~
should theU.S. Congress address, if any... ? The three most ffequent responses forattentionby Congress were: support stmhdmtioneffurta for global
trading; support immobilization of securities; support increasing the standardization oftheckaring and settlement process. It should be pointed out that
a significant number of U.S. respondents did not want increased congressional involvement in issues aHecting the clearing and settlement industry.
~lBM study, op. cit., footnote 58, PP. 20,22.
 Chapter 5--International Clearing and Settlement: What Happens After the Trade ● 69

cates (which some retail investors insist on) and private payment system (i.e., a clearing agency)
reliance on the postal system to accomplish this.@ participant to settle its obligations.72 The guidelines
The retail customer must pay his broker on or before are seen as difficult to apply within NSCC and DTC
the settlement date. Each side requires the delivery for the clearing of corporate securities and municipal
to the broker of either “good funds” or certificates bonds, and therefore will require additional study .73
in a timely fashion. There is no easy way to
Ongoing efforts by the U.S. private sector have
accomplish these “deliveries” today, without sub-
been laudable. Yet, some of the issues raised by
stantial changes for the retail investor or added
shortening the time to settlement and same-day
expense for investors who wish to hold a certificate.
funds, among others, will require continued assis-
The Group of Thirty’s recommendation for a tance from regulatory bodies and, in some cases, the
change from next-day funds to same-day funds U.S. Congress, since they are not within the ability of
(SDF) for the settlement of securities transactions the private sector to resolve.
has no deadline for implementation, but some expect
it to be in place in the United States during the IS AN INTERNATIONAL
1990s.70 The adoption of SDF should contribute to
risk reduction and would add uniformity and sim- REGULATORY BODY NEEDED?
plicity across all instruments and markets. Although the private sector is already dealing
However, the U.S. Working Committee, while with many issues, government assistance is likely to
recommending the eventual adoption of same-day be needed, for example, to effect changes in laws,
funds for the United States, recognizes the need for such as those needed for the immobilization of
assessing a number of complex issues associated securities certificates.74 The several private sector
with its adoption. There are substantive technical studies do not fully address all financial instruments,
issues and the requirement for significant behavioral e.g., derivative products, that must also be addressed
changes that warrant study before the changeover. to accommodate the linked markets of today, nor do
Today’s automated payment systems, for example, these studies address all of the process and infra-
are considered to be not yet sufficiently developed or structure areas that must be examined. The private
‘‘user-tiendly’ to be viable alternatives to the sector alone cannot implement the recommended
postal system. changes fully since consensus will be required
among market participants, regulators, and national
A second issue is that although most major futures governments.75
clearing corporations in the United States settle in
Some of the organizations’ efforts aimed at
same-day funds, there are important exceptions, e.g.,
NSCC and the six regional equities clearing corpora- harmonization have been peripheral to their primary
missions, or one-time activities. The efforts of U.S.
tions and depositories. Further work is needed to
regulatory agencies, that seek incremental improve-
examine how these systems would have to be altered
ments through bilateral agreements, although sus-
to accommodate an SDF environment.71
tained, are slow. Pressures for harmonization are
A third issue concerns implementing guidelines growing, and piecemeal efforts to address these
issued by the Federal Reserve System to mitigate global needs may be inadequate. In other fields of
systemic risk that could be caused by a failure of a international interaction, such as telecommunica-

@~oup of ~, op. cit., footnote 36.

~Mmo~dum from The DTC to the Group of Thirty, U.S. Working COmmitt% J~. 4, 19W.
71~id.
T~ede~~~~e system Docket No. R-(X565, “Policy Statement on Private Delivery-Against-Payment SyStemS,” RIN 7100-~76, June 16, 1989.
73~oup of ~, U.S. Wo~ Comm.ittW Report on Same Day Funds Convention, Fe- IWO.
VASW, GIOUP of ‘III@, op. cit., footnote 36, pp. 6-10.
75The ~oup of ~~ found ~tb~d~co~~~ es~nti~ to -gpro~ss~~oni~ inte~tio~ @s@ smtids and procedures
both in the United States and in other countries. Yet there are indications that important issues, such as the dematerkdization of securities certificates,
may be difilcult to change in the United States in the near term. Some Americans also fear that the recommended reforms, if adopted internationally,
could make other markets more competitive with U.S. markets, weakening our competitive advantage. In spite of such concerns, the Group of Thirty
is making considerable progress, as of late 1989, according to Oerard Lynch Managing Director, Morgan Stanley, who has played a leading role in
developing consensus among U.S. participants. Discussions with OTA staff, December 1989.
70 ● Trading Around the Clock: Global Securities Markets and Information Technology

tions and air and sea transportation, international ● legal issues in cross-border trading,
decisionmaking and standardization, or harmoniza- ● information sharing across markets and across
tion, have long been recognized as essential. Interna- national borders,
tional consensus and standardization are critical to
making global trading practices uniformly accepta-
● the minimum level of technology to be used by
ble. This suggests to some people a need for an various participants with regard to clearing and
international body to facilitate the process. settlement,
● international regulation of markets,
Others argue against such action, because other
countries may resent the United States trying to ● the critical interface between international mar-
change their markets, and fear that this resentment kets and banks,
would generate resistance to U.S. proposals. Nations ● means of protecting clearinghouses from exter-
have different objectives for clearing and settlement nally caused major disruptions,
and contrasting views on the best approaches to ● minimum financial standards for clearinghouses
accomplishing them; some view the protection of (i.e., capital and guarantees),
investors as paramount (as a number of countries,
including the United States, have historically done),
● standards for global custodians, and
while other nations have as their primary objective ● surveillance and enforcement.
greater market share. Some people suggest that the
United States might be disadvantaged if it were to The ability of the United States to unilaterally
focus too narrowly on issues such as safety and develop new standards and procedures for interna-
soundness while other countries focus on gaining tional clearing and settlement is limited. As the need
market share. to develop a broad consensus on these issues in
international forums increases, U.S. regulators must
Perhaps one of the greatest problems in achieving become more knowledgeable about other countries’
a safer global clearing, settlement, and payment regulations, practices, customs, and laws, and more
system is parochialism.76 proactive in seeking accommodations. Federal regu-
The alternative to developing or adapting an lators will need a shared, consistent view of the
international standing body to focus on major issues minimum standards for clearing, settlement, and
is continued reliance on informal or bilateral agree- payment systems on an international basis.
ments—the present approach. These approaches
This subject is discussed in a forthcoming OTA
warrant close examination by the U.S. Congress.
report, Electronic Bulls and Bears; Securities Mar-
At any rate, since the financial markets are private kets and Information Technology, along with com-
markets which involve the public interest, the role of plications associated with U.S. regulatory responsi-
the Federal Government will have to be played out bilities divided among the Securities and Exchange
in concert with suitable private-sector institutions to Commission, the Commodity Futures Trading Com-
achieve public policy goals. Many issues need mission, the Treasury Department, and the Federal
international attention, including: Reserve System.

76A oneob~~erputit: “ . . that unckrthe guise of safeguarding the system and making it more effective and efllcient, the evolution of theregulatmy
system internationally will continue to be distorted in order to advance narrow nationalistic and protectionist puxposes. ‘lb the extent tbat this occurs,
less progress will be made in advancing the primary objectives of regulatio~safety and soundness, competitio~ integrity and consistency. In additio~
theinternational system will fallshortofitspotentialto facilitate economic growthanddevelopment.>’ @anti.,.Reuba~Deputy “
C2@rman of the Bank
of Monlreal, “Implications of Globalization for Regulation and Safety,” a talk at the November 1989, Financial Globalization Confenmce in Chicago.
 Chapter 6
The Regulation of Global Securities Trading

Global trading in securities runs into complex have caused trading to shift at some times in the past.
problems and unnecessary risks because of the For example, the Eurobond market developed in
differences among national regulatory policies and London after a U.S. “interest equalization” tax in
structures. There is no international mechanism for 1964 discouraged the issuance of debt in the United
regulating transborder activities, nor any way for a States by foreign borrowers. A significant amount of
nation to enforce its own regulations beyond its trading in German government bonds is said to have
sovereign reach, except insofar as there are coopera- moved to London to avoid tax in Germany. How-
tive agreements between nations.1 The risks, dis- ever, many examples of movement off-shore offered
cussed in chapters 3 and 5, include both unrecog- by free market advocates cannot confidently be
nized risk for investors who make decisions based attributed to a single simple cause.
on unrealistic expectations of fairness or institu-
tional integrity, and wider systemic risks that might The concept of the pull of less regulated markets
result, for example, from the failure of a major firm is probably too simple for several reasons. First,
with heavy commitments in several countries. At active markets have some natural protections. There
best, there are many complex problems that result is a strong tendency for securities to trade in the most
merely from differences among nations in market liquid market, nearly always in the country of origin.
structures and procedures, in the relationships be- Attempts by a second exchange to compete for
tween securities markets and the banking system, volume trading in an existing heavily traded product
and especially in the regulations that govern these nearly always fail. As noted several times in this
activities. report, this situation may change, especially when
the product is offered in a different time zone. But for
COMPETITION AND trading to shift to another place, the attracting market
REGULATION would have to begin with ample depth, i.e., enough
participants at all times to provide liquidity to those
Many market participants in many countries argue
wishing to trade.
that these differences in regulatory regimes are best
resolved through deregulation in those countries
The more dubious assumption is that the least
with the more regulated markets. Advocates of ‘free
regulated market is necessarily the most efficient
markets,” generally opposed to regulation, use the
market, or the most attractive market to investors. It
threat of international competition to counter any
seems likely that some degree of regulation is
consideration of regulatory action. They are quick to
desired or even demanded by participants for their
argue that additional U.S. regulation or taxation, or
own protection. Beyond this is the question of how
even the maintenance of existing levels of regula-
much systemic risk modern industrial nations are
tion, will “drive the markets overseas.” This
prepared to assume as the price of participation in
argument may or may not be correct, but it is initially
world financial markets. Policy concerning financial
suspect because for many of those who make it, it is
institutions and markets has been, in nearly all
obviously self-serving. The argument should there-
countries and at all times, “protectionist,” because
fore be closely examined.
of the concern of national governments about
Free market advocates assume that trading will monetary control, savings, capital formation, and
inexorably shift to the least regulated market be- financial systems. The policy issues related to
cause it is the least expensive to use, or the “most globalization of securities trading center on how
efficient.” Regulation can significantly add to the much less or how much more protectionist financial
cost of doing business. Mandated costs appear to regulatory policy should be in response to techno-

IGA~ ~ ~ he Pwt cov~ gwds, not s~ms, SemiW industries ~ included for tie f~t time in tie most current round of GA~ negotiations,
but once a general agreement is reached on trade practices in the international services sector, it will still have to be translated into specflc agreements
for different types of services.

–71–
72 ● Trading Around the Clock: Global Securities Markets and Information Technology

logical change and the increasing global mobility of large institutions, assumed to be able to look after
capital.2 themselves.
The exposure of stock market fraud over the last
3 years in several countries-the United States,
TWO KINDS OF REGULATION Japan, France, West Germany, and Canada-has
It is important to recognize that there are two quite given rise to demands for new or more seriously
different kinds of securities markets regulation.3 The enforced prudential regulation or deregulation.5 West
first, which can be called access regulation, is aimed Germany, Belgium, Spain, Italy, and Ireland have
at protecting domestic markets and their participants passed or are considering new laws forbidding
from outsiders; i.e., restricting access to the market insider trading or providing stiffer penalties. In
to maintain the privileges and benefits of “member- Japan, insider training was against the law, but until
ship in the club.” In recent years major market recently it was not considered a serious offense.
nations have reduced these barriers; this has been a When detected, offenders might be reprimanded, but
primary thrust of deregulation in the United King- usually not publicly.6 A stricter law has been passed
dom and France, for example, and even in Japan since the scandals last year, but enforcement is weak.
greater access has been opened for foreigners, In the United States, some people who favor
although more slowly.4 deregulation have suggested that investor protec-
tions should now be relaxed because institutional
The second kind of regulation may be called
investors, guided by professional money managers,
“prudential regulation” and is aimed at assuring
need less protection than the traditional small
investors of fair and equal treatment, by regulating
investor. On the other side, some say that more
trading practices, abolishing fixed commissions,
regulation may be needed to protect the growing
making sure that investors are informed about risks,
number of participants in mutual and pension funds
and requiring the availability of information about
against abuse and mismanagement by fiduciary
prices, fees, commissions, and factors influencing
agents; and some suggest that deregulation in the
prices. Most governments consider it in the public
United States has begun to threaten essential inves-
interest to maintain markets that are fair and have the
tor protections, by subtly shifting to emphasize not
confidence of the public. However, some countries
the “small investor” but the “informed investor,”
put much greater emphasis than others do, on
implying a philosophy of “caveat emptor,” or let
assuring investors of fair and equal treatment. In the
the buyer beware.7
United States, broad participation in securities
markets and stock ownership has been valued as a Prudential regulation of markets still differs
way of democratizing the economy, and investor widely from country to country.8 Regulatory agen-
protection is emphasized. In some countries, there cies in some countries approve nearly any new
have never been many “small investors” or house- trading products, such as index futures contracts,
hold investors, and most market participants are that are proposed by the financial community; other

?llds formulation borrows from a formulation by David D. Hale, Kemper Financial Services Inc., in “How European Economic Integration and
Japanese Capital Power Will Produce Managed Trade in American Financial Services During the 1990’ s,” an ad&ess to the Athens College Alumni
Association Fourth International Economic Conference, 1989. However, Mr. Hale is not responsible for the permutations of his question used in this
chapter.
sMuchof t.hema~in this section~wsonm Gilbert Warren~ “SecuritiesRegulation in the European Communities,’acontractorx’eport
to the OftIce of Technology Assessment, Aug. 1, 1989.
4- are no barriers to foreign membemh“p onU.S. exchanges other tban the requirement tbat members have anoffke in the United States. In 1977
the NYSE further broadened access to trading by providing for (in addition to the traditional purchase of a “seat”) leasing of seats, electronic access
membershl“ps, andafewphysical access memberships with limited participation on the trading floor without other attributes of membership. The National
Association of Securities Dealers has never had barriers to foreign membership. Information provided by the NYSE and NASD.
SFor a brief summary of insider trading rules prior to recent changes seeAn&ew N. GWS, Jr., “Internationalization of the Securities Trading
Markets,” Houston Journal ofZnternationalbw, vol. 9, No. 1, Autumn 1986, pp. 44-49.
6_We~ermd~WdK@4 “The Stock Market in Japam An@emiewand_ysk, “ Congressional ResearchService ReportforCongress,
Mar. 15, 1988.
70’IA workshop on “The Small Investor,”IWiy 1, 1990.
SW -on ~ws ~vily on ~~z~nts for tie R-don ~d Supervision of Securities ~kets ~ OECD Countries,” in OJ3CD: Finuna”uZ
Market Trendk 41, November 1988. Most of the summary statements below apply therefore to OECD countries, which includes all major markets.
 Chapter 6--The Regulation of Global Securities Trading ● 73

countries are more restrictive, on the grounds that types of liabilities that banks may incur are limited.
some forms of trading are basically speculative and Those investing in securities knowingly and by
may lead to excessive volatility or undermine choice assume risks, in return for the opportunity to
confidence in the financial system. Some major profit; they are nevertheless protected to the extent
market countries heavily regulate securities under- of seriously enforced laws against fraud and manipu-
writers and investment advisers; others require only lation, requirements that the investors’ risk be
that there be disclosure of basic information.. disclosed to them, and insurance protection against
the failure of a securities firm. Separation of banking
Countries also differ in the degree to which
and securities activities tends to result in large
competition among financial institutions is restricted--
independent securities houses such as those in the
e.g., whether banks can engage in securities under-
United States, Canada, and Japan. OECD analysts
writing and related activities. Several countries have
conclude that in such systems there may be greater
recently removed regulatory barriers that formerly
acceptance of innovative products than there is in
separated banks, thrifts, securities houses, and other
universal banking countries.10
financial companies. In other countries, chiefly the
United States and Japan, there are still some legal A universal bank system is more common;
restrictions that may affect the participation of banks countries with universal banking (which include
in international securities activities. Austria, Denmark, Finland, West Germany, Luxem-
These differences result in part from historical bourg, The Netherlands, Norway, Sweden, and
circumstance-the way in which national banking Switzerland) allow banks11
to engage in the full range
and payment systems evolved, and when and under of financial activities. These countries assume that
what conditions the existence and importance of the risk of financial failure in any one activity is
securities markets were first recognized. In part, they reduced by the bank engaging in a broad range of
result from differing perspectives on the distinction activities-a form of diversification.
between private and public sectors (i.e., how capital-
A third system allows either banks or brokers to
istic or how socialistic an economy is). A third factor
receive customer orders for securities transactions,
is the constitutional structure of the government: in
but requires the trading to take place through
federal systems regulatory responsibility may be-
independent intermediaries. The activity of dealing
long either to provincial or central government, or be
for a proprietary account is separated from the
dispersed.
activity of trading as an agent for customers. This
may constrain the range of services that stockbrokers
BANKING AND SECURITIES offer. This system is used in Belgium, France,
9
MARKETS Greece, Ireland, Italy, Portugal, and Spain.

In most countries, banks are major participants in These differences in the securities-related powers
securities markets and securities-related activities. of banks result at the international level in the issue
In the United States and Japan, the policy has been of national treatment v. reciprocity .12 “National
to protect the banking system from security market treatment’ means that a country applies the same set
risks. Banking and securities activities are separated. of requirements and regulations to both domestic
People making bank deposits are assumed to be institutions and foreign institutions operating within
trying to safeguard their assets, and are thus given its boundaries. In most regards this should provide
more protection; their deposits are guaranteed up to a ‘‘level playing field’ and promote competition.
a certain limit by government insurance, and the But in the United States, where national laws

%laterial in this section is drawn in part from OECD, op. cit., footnote 8. See also OECD, “International Trade in Services: Securities,” FinunciaZ
Market Trends 37, May 1987; and OECD, ZnternationalTrade in Sem’ces:Banking (I%@ 1988); Bank for International Settlements, RecentInnovations
in International Banking, April 1986; and Banking and Payment Services, materials for an International Symposium sponsored by the Board of
Governors of the Federal Reserve Systeu Washington DC, May 1989.
lOOECD, op. cit., footnote 8, pp. 19-20.
ll~west& rrnany and Austria anyone engaging insecurities trading must obtain a banking license. In the other countries, some fmcial fm which
do not accept deposits maybe licensed to engage in securities activities without banking licenses.
12See OE~, ]nterMtioMl Tr~e in Sewices: Banking, pp. IS-ZO, se ~o An&w T. Hook and M. AIxrto Alvarez, “COXLIpditiOn From Foreign
Banks,” Chapter 10 of Federal Resave Bank of New York NY, Recent Trends in Commercial Bank Profitability, A Staff Study, September 1986.
74 ● Trading Around the Clock: Global Securities Markets and Information Technology

separate banking and securities activities, the banks Italy and Switzerland, some parties-e. g., over-the-
of universal-banking countries are prevented from counter dealers-are not covered.
engaging insecurities-related activities because they
are officially banks. European countries whose Other differences relate to collective investments
banks are officially excluded in this way could in such as mutual funds; there are different prudential
theory demand “reciprocity,” or access to U.S. requirements about corporate structure, fees, and
markets as a condition for allowing U.S. institutions management compensation. The United States has
to participate in their markets. The official U.S. rigorous prudential requirements; many European
position 13 is that: countries are just beginning to develop tougher
requirements after major losses by investors. There
The United States considers reciprocity in finan- have been some efforts to harmonize standards. The
cial services to be inconsistent with the internation- European Community has just adopted common
ally accepted principles of national treatment and standards for mutual funds its member countries.
non-discrimination . . . The national treatment ap-
proach used by the U.S. Government in financial The differences in accounting practices and stan-
services seeks to ensure that foreign firms in the dards, and in capital adequacy requirements for
United States and U.S. firms in foreign countries are various kinds of financial institutions and market
given “equality of competitive opportunity” with
participants are very important and very difficult to
domestic firms.
resolve. Some of these differences were discussed in
The European Community has as one goal of its chapter 5, on clearing and settlement.
“1992 initiative” the establishment of a single
European market in banking and securities activi-
ties. The 1992 Initiative originally included a policy ENFORCEMENT OF SECURITIES
of reciprocity, which has recently been modified. REGULATIONS
14 As securities trading is further globalized, regula-
REGULATORY INSTITUTIONS tors responsible for investor protection face the
The institutional structures for regulating securi- difficulty of supervising activities that flow through
ties markets differ widely. In universal banking electronic systems and networks across national
countries, one regulatory or supervisory agency may boundaries. Currently, the U.S. market regulatory
cover all financial activities15; in the United States, agencies (the SEC and the CFTC) have limited
securities markets, futures markets, bond markets, authority to assist foreign authorities with investiga-
and banks have different regulators. In some coun- tions of violations of foreign laws from a U.S.
tries, primary supervision over securities trading is location. When a foreign government needs U.S.
generally carried out by self-regulatory bodies, such assistance with market investigations, it must ask for
as stock exchanges, under the oversight of a a court order to compel testimony or evidence. But
regulatory agency. This is the case in the United it is often undesirable to have a public hearing while
States, and it is also the case in Finland, West an undercover investigation is in progress. A bill
Germany, and Switzerland, where securities and now before Congress, the International Securities
banking supervisory functions are not separated. In Enforcement Act (H.R. 1396), would strengthen
countries with a federal structure, primary responsi- SEC authority for cooperative enforcement by
bility for supervising markets may be assigned either increasing its ability to punish brokers, dealers, and
to the national government, as it is in the United investment advisors for overseas violations, giving
States, or to provincial or state governments, as it is the agency greater discretion over the release of
in Australia, Canada, and West Germany. In the information, and allowing the agency to accept
United States and the United Kingdom, any entity reimbursement from foreign securities authorities
offering securities or investment services to the for costs of investigations that SEC would conduct
public is regulated, but in some countries such as for them.

13h ~sue pap~fiom tie TJ.S. Dep~ent of the Treasury entitled “EC Single Market: Banking and Securities” provided by the ~temational Trade
Administratio~ U.S. Department of Commerce, Aug. 1, 1989.
IAMuch of tie materi~ in this sectiom not otherwise cited, is drawn fromOECD, op. cit., footnote 8.
15This includes: Austria, Belgium, Denmar IG Finland, West Germany, Luxembourg, Norway, Portugal, Swedeq and Switzerland.
 Chapter 6--The Regulation of Global Securities Trading ● 75

In cases where U.S. markets are abused or In 1985, the SEC proposed the idea of “a waiver
manipulated from overseas, the SEC’s investigative by conduct,” meaning that anyone who traded in
power is limited when the evidence is located U.S. markets would be held legally to have waived
elsewhere. When the SEC seeks help from a foreign the right to prevent the SEC from investigating. But
government, it must make a formal request under the the concept was widely viewed as politically unac-
terms of the Hague Convention or exert pressure on ceptable because it infringed on the sovereignty of
U.S. branches of overseas financial institutions. The foreign governments and created tension with friendly
SEC has been required to go through long negotia- nations.
tions or court proceedings to obtain information
To encourage cooperation from other nations, the
about transactions through foreign banks or securi-
SEC is seeking legislation to authorize it to issue
ties houses. As Charles Cox, a former SEC commis-
subpoenas and take dispositions in this country on
sioner, explained:
behalf of foreign securities regulators or law enforc-
All nations with securities markets may face the ers. 20 It also wants the power to bar from U.S.
dilemma of deciding whether to protect their markets securities markets people who have been convicted
from foreign-based fraud, or to live with markets in foreign courts of certain financial abuses. This,
where some participants can defraud others with however, raises questions of legal rights or justice,
impunity. . . . The acceptable alternative is to de- because foreign governments may lack safeguards
velop ways of sharing surveillance and investigative which are considered essential in the United States
information, and to formalize these arrangements in for those accused of crimes, or may have very
bilateral or multilateral understandings.16 different standards of proof.
Formal agreements have not been completely
effective. In spite of the Hague Evidence Conven- HARMONIZATION
tion some nations refuse to disclose information, and
Many people argue that a worldwide securities
the legal mechanism of letters rogatory have been
regulatory body is needed, but others believe that a
inadequate for gathering evidence for litigation.17
broadly multinational institution with strong author-
While the United States accepts the idea of govern-
ity is not feasible, at least at present. They look to a
ment access to financial data for the purpose of
less drastic solution: “harmonizing” regulation by
enforcing securities laws, some nations view this as
reducing the differences (or the effect of differences)
a violation of confidentiality and may have secrecy
in national regulatory regimes.
or blocking statutes that forbid the release of such
information.18 Secrecy laws recognize confidential- Harmonization is the process of reducing regula-
ity as a fundamental right and forbid any disclosure tory disparities among mutually accessible markets,
of a customer’s financial information, including through the development of common or mutually
business records and accounts, without personal compatible regulatory regimes, standards, and prac-
permission. Blocking laws protect national rather tices. 21 Advocates hope that harmonization would
than individual interests, and are intended to prevent lessen the threat of “regulatory arbitrage,” or
the disclosure of information by citizens as parties to allowing competition among national securities
foreign litigation, or to prevent any foreign govern- markets to force prudential regulation down to the
ment from conducting investigations and imposing lowest common denominator. Critics fear that har-
its policies within their borders, as an invasion of monization could raise the threat of “regulatory
sovereignty. 19 imperialism” in which less regulated markets are

Iwles COX, “Transactions: Blocking the Success of Market Links,” Maryland Journal ofInternational Labor and Trade, vol. 11, 1987, p. 215.
l~id., p. 217.
lsB~onBecker~Tho~ Etter(Securities and ExchangeCommis sion), “JnternationalClearanc eand Settlemen6° 16 BrookZynJ. 271,292-293,
1988.
WA SEC ~v=tig~on of ~spiciow ties o~x ~ fom~ cow~es indica~ tit some U.S. ad foreign investors avoid SEC surveillance
by executing transactions through financial institutions in countries with secrecy and blocking laws. “Problems With the SEC’s Enforcement of U.S.
Securities Laws in Cases Involving Suspicious Trades Originating Abroz@” House Report 100-1065, Oct. 6, 1988.
20H.R. 13%, The International Securities Enforcement Act, now before the Senate.
21W-mop. cit., footnok 3. S* W ~er, “Re@@S F inancial Services in the Unite dKingdom-AnAmerican Perspective,” 44 Buw”ness Luw
323, 1989; and Bernard, “The United Kingdom Financial Services M 1985: A New Regulatory Framework” 21 InternationaZLuw 3431987.
76 ● Trading Around the Clock: Global Securities Markets and Information Technology

forced to become more regulated. Pessimists fear the past have not been very effective. The Interna-
that the effort to achieve harmonization may itself tional Association of Securities Commissions has an
become a form of regulatory arbitrage. organized program for exchange of information, but
the meetings have had little impact. 23 Bilateral
The term “harmonization” itself has in this way agreements through non-binding memoranda of
become controversial, and because it is controversial understanding (MOUs) have been somewhat more
it has become difficult to define. Different stake- successful. They provide flexibility for regulators to
holders, or interest groups, tend to define the term in work out techniques of securities enforcement in a
ways that imply different objectives as well as reamer consistent with domestic law, taking ac-
different approaches. It is necessary to recognize, at count of differing legal systems and culture rather
least, that harmonization allows for two approaches. than demanding complete uniformity. They may
The first, “commonality,” means the development reduce the need for case-by-case negotiation that can
of uniform international rules, such as uniform deplete regulatory resources and cause nearly end-
disclosure requirements, enforced in all countries. less delays, but they are a clumsy solution; each
The second, sometimes called “reciprocity” or country could find itself with many MOUs that are
“comparability,’ calls only for substantially equiv- different from one another. The SEC has MOUs with
alent minimum standards. Canada, the United Kingdom, and Switzerland. The
The North American Securities Administrators CFTC is party to MOUs with the United Kingdom
Association (NASAA) recently urged the creation of and has arrangements with Australia, Canada, and
global minimum standards of investor protection; Singapore for sharing information from monitoring
this is a commonality approach to harmonization. and surveillance activities.
The International Organization of Securities Com-
missions (IOSCO)22 is attempting to develop disclo- The risk with a policy of reciprocity with substan-
sure requirements for multi-jurisdictional securities tial equivalence is that countries with the most
offerings. IOSCO is also working with the Interna- stringent regulations will be led to interpret “sub-
tional Accounting Standards Committee to develop stantial equivalence’ too broadly. They may begin
common accounting rules and standards. Other to interpret their own rules more loosely and enforce
international securities organizations working to- them more slackly, in order to attract or retain
ward commonality, or universal standards, are listed foreign investment in the face of competition from
in box 6-A. countries with less prudential regulation. Then
domestic firms will demand regulatory parity in
The SEC and Canadian provincial regulatory order to compete with foreign fins, and this
authorities have proposed reciprocal recognition of becomes a form of prudential deregulation through
prospectuses in connection with certain types of leveling downward--i.e., another form of regulatory
offerings from specific kinds of issuers; the require- arbitrage.
ments for these perspectuses, although not identical
in the several jurisdictions, show ‘substantial equiv- Many market participants and many regulators,
alence.” This is the comparability approach. The although eager to engage in international trading of
approach of the European Community, in attempting securities and derivative products, are critical of the
to harmonize securities market regulation among its objective of harmonization. For example, in the
members, has shifted pragmatically from common- United States, CommissionerAlbrecht, of the CFTC,
ality to comparability. recently told a public meeting that:24
“Substantially equivalent rules” could be sought Unfortunately, harmonization is a word that those
on a global basis either gradually through a multina- of us at the Commodity Futures Trading Commis-
tional forum or program, or through a series of sion, as well as many in the futures industry, have
informal arrangements. Informal arrangements in come to view with a great deal of suspicion. . . . At

~OSCO includes securities regulators from more than 40 countries.

~B~ker
., and Etter, op. cit., footnote 18; - Note (N eedham), “Insidex Trading Liability,” 16 Brooklyn J. 357,381-385, 1988.
MWMXUP. ~br~ht, “mo-htamtio~ Re@tion of Futures and Options Ivlmketa,” a Speech to the Conference on Futures nd @tiom
Markets in the 1990’s-Innovatio~ Regulation and Jurisdictio~ co-sponsoredby the Commodity Futures Trading Commission and the Futures Industry
Institute, Washington DC, May 2, 1990$
 ...—— - —

Chapter 6--The Regulation of Global Securities Trading ● 77

Box 6-A--International Organizations Related to Coordination of Securities Regulation

The International Organization of Securities Commissions (IOSCO)
Membership: Securities Regulators from about 40 countries. (SEC is the principle U.S. representative with CFTC
as an associate member.)
Aims: Coordination, exchange of information, mutual assistance related to standards and surveillance.
Mechanism: Technical committee and working groups on multinational equity offerings, accounting and auditing
standards, capital requirements and financial ’data, enforcement information exchange, off-market trading, clearing
and settlement, futures markets.
Federation Internationale Des Bourses de Valeurs (FIBV)
Membership: 33 stock exchanges.
Aims: To facilitate exchange of information. Recently concentrating on clearing and settlement, disclosure
requirements, listing procedures.
Mechanism: voluntary information exchange.
Group of Thirty
Also called The Consultative Group on Economic and Monetary Affairs.
Membership: 30 individuals from world-class banks, multinational corporations, government agencies, and
academia.
Aims: To increase policymakers understanding of international economic and financial issues and explore the
international effects of public and private decisions.
Mechanism: Ad hoc committees.
Organization for Economic Cooperation and Development (OECD)
Membership: 24 developed nations. Representation by ambassadors and at selected meetings by cabinet-level
officials.
Aims: Encouragement of economic growth, expansion of world trade. Looks at securities coordination in terms
of international flow of travel.
Mechanism: Permanent research staff, participation of ministers with authority over securities and other financial
institutions.
International Councils of Securities Dealers and Self-Regulatory Associations
Membership: Formed in 1988, membership includes four SROs (Canada, Japan, the United Kingdom, the United
States) and three Securities Dealers Associations (Canada, Japan, the United States).
Aims: To aid and encourage the sound growth of the international securities markets by promoting and
encouraging harmonization in the procedures and effective regulation of those markets, thereby facilitating
international securities transactions and by promoting mutual understanding and the sharing of information among
the members.

the international level, some calls for harmonization tions of foreign firms as they would those carried out
should also be viewed with suspicion. by domestic firms; mutual recognition means that a
country would allow foreign entities to operate
Commissioner Albrecht called on governments to within its jurisdiction as long as they complied with
. .
recognize the importance of relying on market the regulations of their country of origin and “as
forces, saying “Competition is the best harmonizer, long as the rules of the firm’s country of origin are
the best regulator of market forces.” Commissioner comparable to our own. ’ However, the CFTC
Albrecht said that with regard to cross-national participates in international discussions and negotia-
trading, “the CFTC favors a policy combining tions related to harmonization.
national treatment with mutual recognition,’ and he
defined the two terms as follows: national treatment The SEC has indicated a somewhat different
requires authorities in each country to treat opera- approach, saying that an effective regulatory struc-
78 ● Trading Around the Clock: Global Securities Markets and Information Technology

ture for an international securities market must liquid securities market and futures market in the
include: world, and possibly the most efficient, innovative,
and fair markets in the world—although there are
● efficient structures for quotation, price, and
volume information dissemination, order rout-
certainly challenges on several of these fronts.
Assumin g that Congress believes that it is in the
ing, order execution, clearance, settlement, and
payment, as well as strong capital adequacy
public interest to maintain this position, what must
be done to assure our competitive position, while
standards;
safeguarding the interests of U.S. investors, finan-
● sound disclosure systems, including account-
cial institutions, and most importantly, the public at
ing principles, auditing standards, etc.; and
large?
● fair and honest markets, through investor pro-
tection legislation, surveillance, and enforce- A number of international cooperative efforts are
ment cooperation.= underway to achieve harmonization of regulation.
At the end of 1989, the SEC signaled its intention The problem for policymakers is how to be sure that
of encouraging international cooperation in regula- the United States encourages this movement and
tory affairs by creating an Office of International provides leadership for it, without becoming a
Affairs that will report directly to the chairman of the victim of “regulatory arbitrage” in which countries
Commission. The office is to set up information- with much lower levels of prudential regulation set
sharing agreements with other countries and direct the norms. This calls for coherent and consistent
cooperative enforcement efforts. The CFTC also policy positions that American negotiators can
actively participates in many international regula- present and defend.
tory cooperative activities.
One need is to prevent the erosion of the
Many countries are now reviewing their regula- framework of prudential regulation that Congress
tory frameworks in response to the internationaliza- has erected since 1934, as an unintended byproduct
tion of markets. According to OECD: of the effort to achieve harmonization. The second
There is increasing awareness that securities need is to clarify and reassert congressional guid-
market activities involve risks that are comparable to ance over the evolutionary development of securi-
the systemic risks inherent in banking, and that, ties markets as they face the challenge of global
accordingly, the basic question arises as to what trading. There may be differences between the two
extent existing regulatory and supervisory arrange- U.S. regulatory agencies in their approaches to
ments are adequate to deal with current market international regulatory harmonization that could
realities. 27 confuse and hamper American leadership in defin-
ing a desirable regime for global securities trading.
The EC’s 1992 initiative (see ch. 4) provides an
A statement of policy similar to that underlying the
example of how harmonization could be achieved
Securities Act Amendments of 1975 maybe needed.
among major market nations, given sufficient incen-
tive and leadership. If successful, the EC initiative This implies something of a dilemma for U.S.
may stimulate further action toward broad multina- policymakers. A general trend toward deregulation
tional cooperation. The 1992 directives are aims, not and non-intervention has been apparent in the
yet achievements, but enough has been done toward United States as well as in other countries, during the
integrating European markets to make it likely that 1980s. On the other hand, the United States sees
the EC will become a significant factor in interna- many of the advantages of its chief competitor,
tional securities trading. Japan, as resting on the close relationship between
financial institutions, industry, and government, so
that Japanese investment banks operate in a market
AMERICAN LEADERSHIP
guided and insured by the government. There is
It seems reasonable to conclude that the United legitimate concern that unnecessary regulation might
States now has, in the aggregate, the largest and most interfere with the ability of exchanges, over-the-

~C~R@ation of~~rmtio~ s~~ti~ ~kets, ” Policy Statement of the United States Securities and fictinge CO* sion, Washington DC,
November 1988.
~OECD, Op. cit., footnote 8, p. 31.
 Chapter 6--The Regulation of Global Securities Trading ● 79

counter markets, and financial information systems they will seek more freedom from the clock than the
developers to experiment and innovate. There is fear traditional exchange trading hours and floor mecha-
that excessive regulation might make markets less nisms can accommodate. U.S. stock exchanges are
efficient and drive trading to overseas exchanges. so far slow to show any interest in adopting
There are also encouraging signs that some U.S. automated trading systems that bypass or compete
markets are prepared to take a lead in developing the with traditional dealer intermediaries or that operate
technology and institutional mechanisms for global
around the clock.28 U.S. regulators may need to
trading; in this regard the futures markets are far
actively encourage market officials to take a long-
ahead of the stock exchanges.
term view of market development, and U.S. regula-
Large institutional investors want greater transac- tors themselves may have to be encouraged to do so
tion speed, mobility, and opportunities for diversifi- by the U.S. Congress.
cation, and there are already strong indications that

~A forthcoming OTA report, Electronic Bulls and Beardecun”ties Markets andhtfonnation Technology, ~cusses tiese issu~.
 Appendix
Clearing and Settlement in Major Market Countriesl

Clearing and Settlement in the United States banks, and other financial institutions, through about 400
direct participants.
Three clearinghouses and three depositories serve the
Nation’s 7 stock exchanges, NASDAQ, and other over-the- NSCCsS clearance and settlement process normally
counter dealers; 9 clearinghouses serve the 14 futures requires five business days. Trade information is received
exchanges; and 1 clearinghouse serves all the equities either in the form of locked-in trades already matched by
options markets.2 The major clearing members, who also the computer systems of the exchange or market; or, as
clear for non-clearing members of a clearinghouse, tend buy and sell data reported by market participants. The
to be highly automated for lower costs and greater latter still must be compared and buy and sell orders
operating efficiency. For safety purposes, U.S. clearing- matched. Locked-in trades are entered directly in the
houses also tend to be financially structured such that a NSCC computer system on the same day as the trade. This
failing clearing member can be isolated quickly and its sharply reduces the need for the matching of buy and sell
problems resolved without a ripple effect. orders at the clearinghouse level. On a typical day, about
While arrangements between clearinghouses and their 75 percent of the trades on the NYSE are locked-in (a
clearing firms vary, the general goal is that the clearing- smaller proportion by dollar value).4 Figures A-1 and A-2
house maintain adequate resources and commitments to illustrate the steps in the NSCC's clearing and settlement
assure settlement if a clearing firm or its non-clearing firm of retail and institutional customers’ trades, respectively.
customer defaults. These include capital requirements for
members, claims on items in process, if any, as well as Securities which are held for NSCC members by The
claims on the defaulting member’s remaining assets on Depository Trust Co. (DTC), and whose ownership can
deposit with the clearinghouse (e.g., cash, letters of credit, therefore be transferred within DTC via its computer
Treasuries, or securities posted as collateral for margin). book-entry system, are also eligible for settlement
The clearinghouse also has claims on other assets of the through the Continuous Net Settlement (CNS) computer
failed clearing member. The clearinghouse’s guarantee system. This includes the preponderance of trades settled
fired is another resource. Finally, the clearinghouse can through the NSCC. NSCC becomes the counterpart to
make assessments against other clearing member firms. each trade; it guarantees that the settlement obligations of
This succession of fallbacks is a buffer against shocks the trade will be met—both the obligation to deliver
ranging from sudden large drops in the prices of securities securities and the obligation to make payment. For
and futures to defaults by members. As a result, there have locked-in trades, NSCC’s guarantee takes effect at
been few cases of a failure of a clearing member in the midnight on the day (T+l) that the counterparties to the
United States, and no instances of a failure of a trade have been notified that the trades matched.
clearinghouse. 3
Trades that do not match begin a reconciliation process
Equities Clearing Organizations that is being shortened and by the end of 1990 will occur
on the day following the trade (T+l). Those that remain
The National Securities Clearing Corp.--NSCC proc- unmatched by T+3 are returned to their originating
esses 95 percent of all equities trades in the United States. marketplace for face-to-face negotiation. With the in-
It is jointly owned by the principal equities markets: the creasing number of trades locked-in at the marketplaces,
New York Stock Exchange (NYSE), American Stock and with the availability of on-line reconciliation systems
Exchange (AMEX), and National Association of Securi- at these marketplaces, the need for this process is being
ties Dealers (NASD). It serves 1,800 brokers, dealers, eliminated.

l~pmp~ ~ apP~ OTA b refi~ heavily on a contractor report by B@era Trust CO., “Study of International Clearing and Settlement”
vols. I-V, contractorreportprepaxed for the Offkeof Technology Assessmen~ October 1989, to whichmanydozens of institutions and individuals around
the world contributed expert papers and/or served on the Bankers Trust advisory panel. OTA has also used the discussions of an expert worbhop held
at OTA on Aug. 22, 1989.
*or information on the clearing and settlement of U.S. Treasury and government agency securities, mortgagdacked securities, and municipal
securities, see Bankers Trust Repo~ op. cit., footnote 1.
3@e ~~not= ~tthe o~y si~ationhe cmen~sion inwhichthe the Natio~ Securities Clxcorp. (whichcl~ the vut majority of Wuitb
trades ~ the United States) could fai~ would require a major external triggering event, such as the collapse of one or more major U.S. banks causing
the failure of one or more NSCC clearing banks or major clearing members. (Robert Woldow, NSCC, at a meeting of experta on clearing and settlemen~
OTA, Aug. 22, 1989.) The events of October 1987 in the United States-when the payment system began to become clogged-were perceived as
potentially disastrous.
4S~ce Auust 1989, the NSCC &gm c~p~ ~des tit ~ not locked-in during the ~ly morning hours C)f T+l.

-81–
82 ● Trading Around the Clock: Global Securities Markets and Information Technology

Figure A-l-Clearance and Settlement of Retail Customer Trades

[ STEP I . TRADE DATE (T)

MARKETPLACES

Order (I) Execute (2) I Execute (2) Order (1)

SELLING + SELLING + 1 + BUYING ] 4- 1 BUYING ]
Retail 1 Broker I
I Customer 1 IA I —
I t i I + , r I ~ - B l
A
-- L.----J I L - _ - - - J - l
Confirm (3) Trade Trade Confirm (3)
Details (4) Details (4)

1
~ CLEARING
I CORPORATION
I

STEP 2. TRADE DATE + 1 ( T + 1 )]

(
[ SELLING SELLING

L I
Retail Broker
Customer A
A
I
Results I I I I Results
of ( 5 ) + CLEARING + (5) of
Comparison CORPORATION Comparison
w k
I (Trade Comparison)
I
]S TEP 3. TRADE DATE +4 (T+4 )

r SELLING
Retail
Customer ‘ : : : : ’ b m
1 1
: ~
~
B
r
J

1 CLEARING
CORPORATION

(Trade Netting and Issuance of

Receive/Deliver Obligations)
(6)

(1) Retail Customers give orders to buy and sell stock to their respective Brokers,
(2) Brokers execute Retail Customers orders in the Marketplaces.
(3) Brokers confirm back to their respective Retail Customers that the trades were executed.
(4) Brokers submit details of trades executed in the Marketplaces to the Clearing Corporation.
(5) Clearing Corporation generates reports back to the Brokers indicating the results of comparison.
(6) Clearing Corporation nets the trades.
(7) Clearing Corporation issues projection reports indicating net receive/deliver obligations to the buying and selling Brokers,

SOURCE: NSCC, 1990.

 Appendix--Clearing and Settlement in Major Market Countries . 83

Figure A-l-Clearance and Settlement of Retail Customer Trades-Continued

[STEP 4. TRADE DATE + 5 (T+ 5 } ]

(8) (13)
SELLING Shares SELLING BUYING
1
Shares BUYING
Broker Retail
B Customer

(9) (12)
Shares CLEARING Shares
CORPORATION
t
i

Instructions + (lOa) (1 la)

SELLING BUYING
Broker A Acct CLEARING CORPORATION ACCOUNT Broker B Acct

Ishares (10b)! shares +[11b) \ shares I

I DEPOSITORY I

(16) (14)
SELLING Money SELLING BUYING Money BUYING

w
Retail Broker Broker Retail
A
L.YI.-I
Money Money

(Money Settlement)

(8) Selling Retail Customer A gives shares to selling Broker A to satisfy delivery obligation.
(9) Selling Broker A deposits selling Customer A’s shares in its account at the Depository.
(lOa) Clearing Corporation instructs Depository to debit selling Broker A’s account and credit Clearing Corporation’s account with the shares;
(lOb) Depository debits selling Broker A’s account with the shares and credits Clearing Corporation’s account.
(1 la) Clearing Corporation instructs Depository to debit Clearing Corporation’s account and credit buying Broker B’s account with the shares;
(1 lb) Depository debits the Clearing Corporation’s account with the shares and credits buying Broker B’s account.
(12) Buying Broker B requests withdrawal of shares from its account at the Depository In order to deliver to Retail Customer B,
(13) Buying Broker B delivers the shares to its buying Retail Customer B.
(14) Buying Retail Customer B pays buying Broker B for shares received.
(15a) Clearing Corporation advises buying Broker B of net pay amount for shares received;
Buying Broker B delivers a check to Clearing Corporation for the requested amount,
(15b) Clearing Corporation advises selling Broker A of net collect amount for shares delivered;
Clearing Corporation issues check to selling Broker A for the specified amount.
(16) Selling Broker A pays selling Retail Customer A for shares delivered.

SOURCE: NSCC, 1990.

84 ● Trading Around the Clock: Global Securities Markets and Information Technology

Figure A-2-Clearance and Settlement of Institutional Customer Trades

STEP 1 ––—–
TRADE DATE ( T )“-’

MARKETPLACES
— –T–
Execufe (2) I Execute(2)
[ I

4{
S E L L I N G
{ Order I SELLING
–
BUYING Order BUYING
-

+—–—– . L + -
Instltut!onal Broker Broker Institutional
Customer -1 ~ 0 (1) Customer
A J L- ——.— J B
1
Trade Trade
Details (3) I Details (3)
~ ’ – — - l
CLEARING
CORPORATION

– –
. . ———————- _. .-. . ,
STEP 2 TRADE DATE + 1 ( T + 1 ) ,
(6) (6)
-
‘SELLING
-
I ID SELLING ] 1 - BUYING j ID BUYING
Institutlonal I Confirmation Broker I Broker Confirmation Institutional
Customer I ~ ‘
-
A , B + Customer
A [ B
-.J

‘+ (4)
I Results of CLEARING I Results of I {
Comparison CORPORATION Comparison
ID , ~ ID
Confirmation (Trade Comparison) Confirmation
(5) ‘+ + (s)

SELLING I
Broker A Broker B I Bank B
Account I Account Account ( Account
I
1
DEPOSITORY
— —
I. STEP
. 3.
— — TRADE DATE + 3 ( T + 3 ) OR TRADE DATE + 4 ( T + 4 ) —~
(7b) ~-.%– (8b)
BUYING ID r-BUYING
SELLING Institutional:= ID Affirm;:. Broker Broker Affirm Institutional
~ —
Customer + A B Customer
A I +
“ [ - - - .-;–_.

(7a) CLEARING [8a)

[ ID CORPORATION ID
i Affirm Affirm I

\ CUSTODIAN I SELLING I CLEARING CORPORATION ACCOUNT BUYING CUSTODIAN ]

~ - Bank A Account I BrokerA Broker B Bank B + J
] Account Account Account
F
L -
F-”-””- L–-.—_ . .
DEPOSITORY
. ..—

:::-:--”-5
(1) Instltutlonal Customers give orders to buy and sell stock to their respective Brokers
(2) Brokers execute Instltutlonal Customers orders In the Marketplaces
(3) Brokers submit details of trades executed m the Marketplaces to the Clearing Corporation
(4) Clearing Corporation generates reports back to the Brokers indicatlng the results of comparison
(5) Brokers send ID confirmation to the Custodian Banks of their Customers
(6) Brokers send ID confirmation to their respective Institutional Customers
(7a) Selling Instltutlonal Customer A sends ID affirmation to Custodian Bank A to deliver securities on settlement day (T+5) to Its’ Broker (A)
(7b) Selling Instltutlonal Customer A sends 1D affirmatlon to selling Broker A indicating that Custodian Bank A WIII deliver
the securities to it on settlement day
(8a) Buying Instltutional Customer B sends ID affirmation to Custodian Bank B, notifylng it to receive securities on settlement day from its’ Broker (B)
(8b) Buying Institutional Customer B sends ID affirmation to Broker B, instructing it to deliver securities to its’ Custodian Bank (B)
on settlement day

SOURCE: NSCC, 1990.

 Appendix--Clearing and Settlement in Major Market Countries . 85

Figure A-2-Clearance and Settlement of Institutional Customer Trades-Continued

IS TEP 4. TRADE DATE + 4 ( T + 4)]

r
SELLING + BUYING 1 BUYING

Selling Instit. Customer

B r o k e r A
II A I
1 — ~
—
CLEARING
CORPORATION
(Trade Netting and Issuance of
Receive/Deliver Obligations)
(9)

‘STEP 5. TRADE DATE + 5 ( T + 5 ) J

— . –
SELLING- SELLING I BUYING I
BUYING
Institutional I Broker Broker Institutlonal
Customer
A
A B I
I
I Customer
B
I
d . ’

CLEARING
CORPORATION

(12a) (13a)
Instructions ~+
I

I CUSTODIAN I SELLING CLEARING CORPORATION ACCOUNT

I Bank A
Account
I Broker A
I Account
I shares I shares-
I (11) (12b) (13b)
DEPOSITORY

lSTEP 6. TRADE DATE+ 5 (T+5) 1

e
~D•Œ ‘ ’’ ’ie !
b gat
El
BUYING
Institutional
Customer
B

1’
I
I
CORPORATION
(Money Settlement)
~
I ‘1

I I
I CUSTODIAN I SELLING CLEARING CORPORATION ACCOUNT BUYING I CUSTODIAN I

-IJ::E2
(9) CIearlng Corporation nets the trades
(10) Clearing Corporation issues projection reports Indlcatlng net receive/delwer obligations to the buying and selling Brokers.
(11) Custodian Bank A instructs Depository to transfer shares from its account to selling Broker A’s account,
Depository debits Custodian Bank A’s account and credits selling Broker A’s account with the shares
(1 2a) Clearing Corporation Instructs Depository 10 debit selling Broker A’s account and credit its’ account,
(12b) Depository debits selling Broker A’s account and credits Clearing Corporation’s account with the shares
(13a) clearing corporation instructs Depository to debit Shares from its account and credit shares to buying Broker B’s account,
(13b) Depository debits Clearing Corporation’s account with the shares and credits buying Broker B’s account
(14) Buying Broker B instructs Depository to transfer shares from its account to Custodian Bank B’s account,
Depository debits Broker B’s account and credits Custodian Bank B’s account with the shares
(15) Custodian Bank B pays buying Broker B for shares received
(16) Monies from Custodian Bank B to Broker B are used by Broker B to meet Its settlement obligation to the Clearlng Corporation
(17) Clearlng Corporation receives rnonies from Broker B and pays to Broker A
(18) Monies from Clearlng Corporation to Broker A are used by Broker A to meet Its payment obligatlon to Custodian Bank A

SOURCE: NSCC, 1990.

86 ● Trading Around the Clock: Global Securities Markets and Information Technology

Using the CNS system, the NSCC calculates each day NSCC protects against credit risk, first of all, by
a net long or short securities position for each CNS- retaining a lien over securities which the receiving
eligible security that was traded by the clearing member participant has not paid for. For trades not settled by T+5,
on that day. The number of settlement transactions and the NSCC uses a mark-to-market procedure to limit its
gross amount of the clearing member’s obligation either market risk until settlement does occur. Market risk is
to deliver securities or to make payment is adjusted by the kept to l-day’s market movement by adjusting members’
amount of any securities or payments that it would receive settlement obligations to current market prices. Members
as a result of other trades of the same security. This type pay or are paid at settlement based on the current value of
of calculation process is known as netting. It reduces the their open positions on and after T+5, rather than their
total number of securities to be delivered or received, and value when they made the trade. In the interim, until the
the number and size of aggregate cash payments. As a position settles, members pay or receive the net difference
result of this process of offsetting obligations, the NSCC in market price movement. NSCC’s guarantee fund for
estimates that movement of about five-sixths of the total CNS takes account of potentially adverse movements on
daily transactional volume of owed securities and cash trades which have not settled before T+5. It is based on the
payments otherwise required on the settlement date is total size of all positions open. These include those
eliminated. Netting may indirectly increase market liquid- pending (before settlement); trades settling on T+5; and
ity by reducing the gross amount of funds necessary to trades for which T+5 has passed and settlement has not
meet settlement obligations. After netting through CNS, occurred. In addition, a percentage of the market value of
the NSCC then informs the DTC of the net amount that securities for next-day (T+l) delivery must be deposited
each counterpart owes in securities on the settlement in order to protect the NSCC in the event the member
date, T+5. The DTC, using its book entry system, records defaults. This calculation is done daily for all members
the transfer of ownership by debiting the securities and can be collected more frequently than the monthly
account of the delivering counterpart and crediting the norm. All NSCC clearing members are required to
account of the receiving counterparty.6 Payment on the contribute to the guarantee fund. NSCC’s total funds on
settlement date is in the form of a certified check, payable deposit, not including lines of credit, totaled over $400
to the NSCC. When settlement cannot be made on ‘the million in 1989 and 1990.
settlement date-e. g., when the securities are not availa-
ble in the participant’s DTC account-these obligations The NSCC also maintains a full compliance-
remain in the CNS system and are carried forward and monitoring system to ensure its continuing ability to
netted with the next day’s obligations. judge the creditworthiness of its participants.8 It shares
risk information with other SEC-registered clearing-
Securities that are not eligible for the CNS system may houses, both through the SEC’s Monitoring Coordination
be settled either through balance order accounting or on Group and the Securities Clearing Group. NSCC and a
a trade-for-trade basis. These other forms of settlement number of futures clearinghouses are now discussing
comprise a very small percentage of trades settled through proposals for increasing the sharing of risk information;
NSCC. e.g., data on market participants’ holdings on various
exchanges.
In 1989, the fail rate-the percentage of trades which The NSCC is linked to its clearing members by means
do not settle on the settlement date-in trades cleared of the Securities Industry Automation Corp. (SIAC),
through CNS was 8.13 percent of the total net dollar value which operates NSCC’s technology base. Most partici-
of cash and securities due on the settlement date. Since the pants now have direct computer links; only about 1
NSCC takes the counterpart position and guarantees the percent of the full-service members continue to report
settlement of all CNS-matched trades, NSCC is exposed trades via computer tape.
to various credit, market, and non-market risks.7 The ways
in which clearinghouses protect themselves against such All payments to NSCC are on a net basis; i.e., the
risks are critically important. NSCC calculates each clearing member’s total credit and

5This appendix tiscusses interdealer and institutional (street-side) settlement only. Concerning depository functions, a broker cm make *1’f.lement

with his institutional customer through DTC’S ID program. A description of customer (retail) settlement is provided by the Securities and Exchange
Commission in vol. II of the OTA contractor report: Bankers Trust, op. cit., footnote 1.
GStock held by DTC is in nominee name and appears on the books of the transfer agent of the issuing company. h a typical -reaction, the -=
agent would not be involvedin the change of ownership. The change in ownership between the parties to the transaction would occur solely on the books
of DTC. If, however, a broker or his customer wishes to have the shares registered in his own name, he instructsDTC to send the appropriate quantities
of stock currently in street name, to the transfer agen~ who would then send the reregistered shares directly to the broker.
7C~t risk refers to the possibility that a p@cipz@ might not pay for or deliversecurities. Market risk reftXS to tie priCe Cqes of the -v.
Non-market risks include loss of dq human error, systems failure, or any breakdown caused by any factor other than creditor market factors.
8NSCCJS STARS system monitom project~ settkrnent exposures from the time trades are matched until they are titimately setfl~. NSCC also
employs a series of exception reporting mechanisms to detect security concentratio~ settlement pattern changes, and security price changes.
 Appendix--Clearing and Settlement in Major Market Countries ● 87

debit positions and nets to a single figure that is either on futures contracts. CME has a Clearinghouse Division.
owed to NSCC or is owed by NSCC. Payment to NSCC This system and other U.S. futures clearinghouses, are
is by certified check. Funds are concentrated in one similar (although not identical) to that at the BOTCC.ll
central clearing bank. If a certified check is not received
on the settlement date, then payment via FedWire is BOTCC has an on-line trade entry/trade capture system
required the next morning. NSCC pays selling members that allows it to receive over 75 percent of its trade
with regular bank checks, but intends to move towards the information through on-line terminals (with the user
increased use of electronic payments as one way to keying in data). The remaining 25 percent of trade
improve the settlement process. information is reported by means of computer-to-
computer transmissions. In addition, members of the
The International Securities Clearing Corp.—ISCC BOTCC that are also members of the CME may use the
is a subsidiary of the NSCC and is an SEC-registered BOTCC’s on-line trade entry/trade capture technology to
clearinghouse. It was founded in 1985 to assist in clearing send trade information to the CME. About 20 percent of
and settlement and to provide custody services for the CME’s trade information arrives at the CME clearing-
securities traded among American brokers and banks and house through the BOTCC trade entry/trade capture
their counterparties across national borders. It has links technology.
with clearinghouses and depositories in foreign markets, 9
including: Once a trade has been captured, BOTCC employs a
two-sided matching system in which both the buy and sell
the International Stock Exchange (ISE), in London; sides of a trade are submitted to the trade comparison
● the Centrale de Livraison de Valeurs Mobilieres system for matching. This capability provides the benefits
(CEDEL), in Luxembourg; of comparisons on the day of the trade, and a match by
● 20 depositories and custodians in Europe and Asia, broker and by counterbroker as well as a match within the
indirectly linked by means of a conduit provided by clearinghouse. This is the standard for futures markets in
CEDEL; the United States, except for the New York Mercantile
● the Japan Securities Clearing Corp. (JSCC), the Exchange (NYMEX), which uses a one-sided trade
Tokyo Stock Exchange’s clearing and custody matching system, in which ‘‘sell’ information is put into
organization; the system and the clearing member with the “buy”
the Central Depository subsidiary of the Stock information must confirm the data at a later time.
Exchange of Singapore; and
● the Canadian Depository for Securities (CDS), in BOTCC’s guarantee to clearing members that the
Toronto, linked through NSCC. settlement obligations of the trade will be met begins at
the moment a trade has been matched and registered. At
ISCC also serves as the clearing system for the NASD’s that time, typically about 1 hour after the final trade
PORTAL market for foreign private placements exempt submission, the clearinghouse becomes counterpart and
from SEC registration by virtue of Rule 144A. (See ch. 3.) guarantor to every trade.
Futures Clearing Organizations10 In all U.S. futures markets, both buyer and seller make
The Board of Trade Clearing Corp.—The Chicago a good faith deposit to the clearing member firm; this is
12

Board of Trade (CBOT), which handles the greatest ‘‘original margin. " The amount required per contract is
volume of futures contracts trades in the United States, determined by the exchange, and is due from both parties
to the trade on the morning of the day after the trade (T+l).
has its own separately incorporated clearinghouse, the
Most clearing members maintain substantial excess
Board of Trade Clearing Corp. (BOTCC). With approxi-
mately 139 clearing members, the BOTCC is by far the original margin deposits in their clearing account at the
BOTCC. The amount of margin a clearing member owes
largest clearing organization serving the futures markets.
is calculated by the clearinghouse based on the value of
The Chicago Mercantile Exchange (CME) is the largest his open contracts and an assessment of the amount of risk
U.S. futures exchange when measured by another yard- those contracts involve. The BOTCC uses its risk
stick, the average total value of open futures and options assessment computer system SAFE [Simulated Analysis

9The ISCC is also discussing the possibility of setting up another 1- with the Societe Interprofessiormelle pour la Compensation des Valeurs
Mobilieres (SICOVAM), the French central depository, and with Societe des Bourses Francais, the broker clearing system at the Paris Bourse.
lohluchof tie information in this swtion is based on Roger D. Rutz, ‘Clearance, Paymen~ and Settlement Systems, in the Futures, optiOnS, and Stock
Markets,” Feb. 24, 1989, a contributed paper in the OTA contractor report: Bankers Trust, op. cit., foomote 1.
llFor de~~ on tie cle~g ad se~ement processes at tie o~er U,S. fi~es cle~houses, see OTA contractor report by Bankers ‘h@ Op. Cit.,
foomote 1.
~ZT’Ilis @@MI m~gin deposit is a perfo~nce bond to protect the fwciai integrity of the clearinghouse in the event that the cl-g f~ is ~ble
to meet a margin call or to make or take delivery. Original margin refers to deposit of funds in the form of cask government securities, or letters of credit.
There are two levels of margin: the fwst is from the customer to the f~ the second is from the fm to the clearinghouse.
88 ● Trading Around the Clock: Global Securities Markets and Information Technology

of Financial Exposure] to evaluate clearing member requires its clearing members to post margin, the greater
firms’ credit, and uses the CME’s SPAN to determine the is the financial integrity of the clearing system.
amount of margin owed.13
Lines of Defense—In the futures markets, the maxi-
There are two methods of calculating original margin: mum potential default liability represents at most only
gross margining and net margining. Gross margining one business day’s market movement. This is the first line
requires a clearing member to post original margin on all of defense for the clearinghouse. The BOTCC segregates
the long and short positions in these accounts; they cannot and nets proprietary and customer open positions of each
be used to offset each other in case of a deficiency. By clearing member across commodity futures and options
contrast, with net margining the margin owed by each contracts to calculate the amount of both the original and
clearing member is calculated on the difference between variation margin of each clearing member. The BOTCC’s
all the long and short positions, calculated separately for SAFE system calculates each clearing firm’s potential
proprietary accounts and customer accounts. The BOTCC exposure to an adverse move in prices.
figures original margin on a net basis, as do most U.S. Margin deposits are the second most important line of
futures clearinghouses; the exceptions are the CME
defense in protecting the clearinghouse from a default by
Clearinghouse Division and NYMEX, which figure
a clearing firm which could affect other clearing mem-
original margin on a gross basis.
bers. The Commodity Futures Trading Commission
The BOTCC’s trade-matching process, from the time (CFTC) requires that all clearing members maintain two
it guarantees settlement obligations to the posting of bank accounts for settlement and two safekeeping ac-
original margin by clearing members, may take 7 hours.14 counts for original margin. One set of bank and safekeep-
During this timelag, the BOTCC carries the full risk. ing accounts is for original and variation margin for
Clearing members demand that trades become guaranteed customer positions, while the other set is for original and
as quickly as possible, since this is the point at which variation margin for proprietary and non-customer (affili-
counterpart risk should be eliminated. ated firm) positions.17
Another line of defense for the clearinghouse is its net
Besides original margin, futures clearinghouses also capital requirements for clearing members. In addition, all
calculate and collect variation margin.15 The amount U.S. futures clearinghouses share certain types of “risk
reflects the changes in the value of a clearing member’s information’’--data on amounts paid and collected by
open contracts. Variation margin may be collected daily, clearing members in the form of both original and
or more often. The BOTCC routinely issues one morning variation margin, reflecting their overall exposure, and
call and supplemental intra-day variation margin calls amounts paid by clearinghouses to clearing members,
(usually around 2 p.m. c.s.t.).16 One purpose of routine representing reductions in the amount of risk faced by a
intra-day variation margin calls (and payments to clearing clearing member.
members with profitable trades) is to reduce the magni-
tude of the following morning margin call, which is Still another line of defense in protecting the clearing-
always made at 6:40 a.m. c.s.t. on the day following the house from default by a clearing firm is its authority to
trade date (’I’+ 1). As a result of this system, the BOTCC issue a‘ ‘super’ margin call if the BOTCC determines that
typically collects (and pays out) by about 2:30 p.m. c.s.t. a customer or proprietary position represents a clear and
on the date of the trade between 60 and 95 percent of the immediate danger (i.e., a particular market condition
final settlement calls that would otherwise have been could cause a substantial amount of a clearing firm’s
made at 6:40 a.m. c.s.t. on the following day. This reduces capital to be depleted because of customer defaults). The
the clearinghouse’s risk because the shorter the period of clearing member would then be required to deposit the
time between trade execution and settlement, the more additional “super” margin (in the form of cash, U.S.
certain it is that a clearing member will be able to meet its Treasury securities, or letters of credit) within one hour of
obligations. In general, the more frequently a clearing- receiving the call. Finally, the segregation of customer
house settles (marks to market) trades each day, and funds, clearing member net capital requirements, and
13~e CME biw its OWQ risk management computer system-SPAN (Standard Portfolio Analysis of Risk)--for detm the amount of margin.
The fatures industry (with the exception of the Intermarket Clearing Corp. (ICC), which uses the system known asTIMS) is moving towards adopting
SPN as the standard for calculating margin.
ld~went of ~g~ mWt be ~ ~e+y tids+.g., those provided by the Federal Reseme’s Fed* el@~Qic PaY’meQt sYs~em.
15V~tion~@ me the cash flow required to mark positions to market. They flow through the cl- g organization to the clearing member on
the other side of the trade,
160f~e U.S. fi~es Clemouses, the cm C1e@o~ Divisio~ the Comx cl~g~socfitio~ and the Coffee, Sugm~d @cOa Cl-
Corp. ah issue routine daily intraday variation margin calls. The others have the capability of doing soon an as-needed basis; e.g., in times of severe
market volatility.
IT’r’he segregation of customer and proprietary funds is a requirement of Section 4d(2) the COQUQOd@ Exc@e ~t.
 Appendix--Clearing and Settlement in Major Market Countries . 89

ongoing financial surveillance, each contribute to bolster- settlement bank decides that it cannot meet the financial
ing the integrity of these markets. obligations of a market participant, the participant will ask
his credit banks for credit. This process generally works
If, despite margin calls, a clearing member nevertheless well, but it depends on two assumptions: first, that the
defaults on the settlement obligations of the trade, the market participant will be able to reach the account
clearinghouse has several protections against liability for officers at the credit banks within the permitted time; and
the default. The clearinghouse may liquidate the clearing second, that the credit banks (which do not always
member’s positions and original margin, sell his ex-
coordinate a market participant’s various lines of credit)
change membership, use his contributions to the clearing- will not extend more credit than a clearing member is
house guarantee fired, use the clearinghouse guarantee worth. Generally, these assumptions are sound, as firms
fund and its committed lines of credit, assess all clearing
usually have a predetermined credit line. But, if a firm is
members, where permissible, and finally, use the clear-
having difficulty, if the firm’s needs come during a period
inghouse’s capital.
of market stress, a settlement bank may decide not to
All U.S. futures clearinghouses have funds available to honor a margin call, and this could result in the
protect themselves against default by their members; clearinghouse liquidating the clearing member’s cus-
these are primarily made up of mandatory contributions tomer positions, after attempting to transfer these posi-
from clearing members.18 They fluctuate in size. Most tions to another clearing member.20
U.S. futures clearinghouses, but not the BOTCC 19 or
Clearinghouses, in respect to intra-day margin pay-
Kansas City Board of Trade Clearing Corp., also have the
ments batch process trades rather than processing each
power to assess their members, if the amount of a clearing trade as it is executed. Thus, a clearinghouse may not be
member default cannot be covered by capital funds and
able to eliminate their risk instantaneously by shifting it
the guarantee fund.
to clearing members. One reason the clearinghouses are
The BOTCC uses four settlement banks, all based in forced to do batch processing is that the banking system
Chicago. The BOTCC’s morning payment process (6:40 moves too slowly to accommodate any other method. For
a.m. c.s.t.) precedes the opening of the FedWire system instance, Chicago banks generally use paper-based proc-
and hence requires the settlement bank to extend credit on esses to move money among clearing members.
behalf of some clearing members. At times, this credit
The working interface between the clearinghouses and
extension may not be fully collateralized, and thus is a risk
the banks survived with difficulty under immense strain
for those settlement banks.
in October 1987.21 In further improving this interface,
Clearing members must maintain accounts at settle- there are cost-benefit trade-offs. The existence of a
ment banks for the payment of original and variation Clearing Organization and Banking Roundtable that
margin, including final settlement payment. When the provides settlement bankers, clearing organizations, and
clearinghouse determines the amount of margin owed, the regulators with a forum for regular discussion of these
clearinghouse notifies the clearing member’s bank of this tradeoff issues, is some evidence that the system is
amount. The bank then examines the clearing member’s moving towards a more secure, less volatile, but still
assets (cash, government securities, lines of credit), competitive, state.
gathers incoming payments from the clearing member
(via FedWire, if it is available at the time the bank is Options Clearing Organizations
making the decision), and makes a commitment to the
clearinghouse as to whether it will honor the margin call The Options Clearing Corp,--OCC is the common
by forwarding the funds to the clearinghouse. entity serving all securities options exchanges in the
United States22 The OCC clears and settles options trades
If the clearing member does not have sufficient assets for the Chicago Board Options Exchange (CBOE); the
to meet its margin obligations, the bank’s decision is American Stock Exchange (AMEX); the Philadelphia
whether to extend credit to the clearing member. When a Stock Exchange (PHLX); the New York Stock Exchange

lsne BOTCC does not bve a guarantee, or clearing fund, but does require clearing members to purchase its capital stock when fieY me fitt~
to membership, which is similar to a guarantee or clearing fund. The relative number of shares of stock that a BOTCC clearing member must pumhase
is adjusted semi-annually to reilect its open positions and trading volume. Other futures clearinghouses have guarantee funds based on capital, trading
volume, or open positions. Rutz, op. cit., footnote 10, pp. 23-27.
1% mid-lg8g, the BOTCC estit~ as $325 million the total value of its available trustfpnd, lines of cred.i$ and ckXu@ghOuse @Pi~.
~oradditionalinfonnation, see AndreaM. Corcoranand SusanC. Erv~ “Maintenance of Market Strategies in Futures Broker Insolvencies: Futures
Position Transfers From Troubled Firms,” Was~ingfm und Lee Z.uw Review 44:849, 1987, pp. 849-915.
zl~m is di==mment ~o~ p~cip~ts ~emselves aS to whether these systems “survived with diffkU.lty,” “~ely ~~ed,” or Perfofi
otherwise. Nevertheless, many improvements have bee~ and are, being implemented to strengthen the clearing and settlement process.
22~ WC clws ~ exc~~~ad~ s=fities Optiom, For de~s oncl- ~d se~ement of optiom on fu~es con~cts, see Bankers Trust CO.,
op. cit., footnote 1.
90 ● Trading Around the Clock: Global Securities Markets and Information Technology

(NYSE); the Pacific ‘Stock Exchange (PSE); and the member’s open positions) at the end of each trading
National Association of Securities Dealers (NASD). session. If the options contract loses value, the OCC
reduces the amount of margin required. When the holder
Unlike the clearinghouses already discussed, the OCC of an option contract decides to exercise it and actually
does not do trade comparison, since it receives locked-in buy or sell the underlying product of the option, the
data on compared trades from each of the exchanges. The person who originally sold the option is not necessarily
exchanges have chosen to keep their own trade-matching the same person that OCC will require to fulfill its terms.
systems as a means of competitive differentiation. The Instead, the OCC randomly assigns a clearing member to
data on matched trades is sent to the OCC by computer on honor the delivery or purchase obligations of the option,
the day of the trade. The OCC then must calculate the from the pool of all clearing members who sold options
amounts of money that are owed and due the next day with identical contract terms.
(T+l) by the buyer and the seller. In the case of the buyer,
the entire amount of money owed to the OCC is called the For example, when an IBM option is exercised, the
“premium obligation,” or “premium,” and is paid in OCC assigns a clearing member with a short position and
cash. The premium, while paid to the OCC, is passed on then sends delivery instructions to an equities clearing-
to the writer of the option. To the buyer of the option, the house such as the NSCC, which incorporates instructions
premium is the amount he pays to lock in the possibility to deliver or receive into its Continuous Net Settlement
of an advantageous movement in the price of the (CNS) system. Any obligations not netted out through
underlying security. To the writer of the option, the normal CNS procedures are settled by instructions to a
premium is the maximum amount of profit he can expect. depository (e.g., the DTC). Delivery of the IBM stock is
If the market moves against the writer, the premium then made by transferring it from the seller’s account into
might, at best, offset only a small portion of the option the buyer’s account at the depository, subject to the CNS
writer’s losses. system. 25
The writer of the option always owes margin to the
When a foreign currency option is exercised, the
OCC each day that the option contract is in effect but has
foreign currency underlying the option contract is deliv-
not been exercised by the holder. This margin23 is similar
ered to the OCC’s cash account at a designated overseas
to the margin owed by the buyer or seller of a futures
bank, and then transferred to the account of the market
contract, essentially ‘good faith’ money which serves as
participant who is buying the foreign currency. The
an assurance to the OCC that the writer of the option has
designated foreign exchange delivery bank may be any
the financial ability to meet the potential obligations of the
bank designated by the parties involved in the transaction,
option that he has sold. The amount of margin owed
not necessarily one of the OCC’s settlement banks.
reflects changes in the market price of the option as well
as a portion of the total amount that he would have to pay The OCC provides its clearing members with a
if the option were exercised. guarantee on the morning of the day following the trade
On the day after the trade (T+l), the OCC notifies the (T+l), after the buyer of the option has paid the premium
buyer of the amount of cash premium which is owed; at obligation, 26 The OCC guarantee protects the holder of an
the same time, the writer of the option is notified by the option against the possibility that the option writer might
OCC of the amount of margin that is owed Both amounts default on the payment or delivery obligations of the
are due on T+l. On the next day (T+2), and each day option.
thereafter until expiration, exercise, or closeout24 of the
option contract, the OCC calculates and then collects Lines of Defense—The OCC’s first line of defense
margin from the writer of the option. against the potential for clearing member default is its
continuing monitoring of the creditworthiness of its
Margin thus reflects the adjusted daily value of the clearing members. The options exchanges have limits on
option writer’s open positions (the total amount of money the aggregate amount of open positions that any one
which he could be forced to pay if the options he sold were market participant may carry at any one time. These are
to be exercised by the holders). The OCC marks to market net limits-i. e., the market participant’s short positions
(determines the adjusted value and liability of each are offset by his long positions. The clearing members’

zsFOrmarginpaymen@ the (XX accepts cash and collateral including: bank letters of credi$ U.S. Tnasury obligations, the actiqitim ~d@Y@
particular option contracts, and various other stocks. Additionally, margin obligations can be reduced through corresponding long positions in othex
options which have the effect of reducing net exposure.
~The “clos~ut” is when a writer or holder of an option contract enters into anotheroption COntraCti -w ~ OffSet@g Positiom
~~aNSCC ~comomtes delivew ~~ctiom ~to i~ ~S ~stem, NSCC rather tin ocC ass~es responsibility for, ~d guarantees, deliveries
and payments.
2~~ fd~a~ec~e~th~e SEC, cmenflyvn~g approv~, Whichwouldprovide WC clefigme~rswith~ UncOnditiO@_@
on the morning of T+l.
 Appendix--Clearing and Settlement in Major Market Countries . 91

positions are monitored daily by the exchanges in respect The net figure reflects, among other things: a) the cash
to these position limits. premium obligation due on each new long position; and
b) the margin due for each new short position. The OCC
The Securities and Exchange Commission (SEC), the
then sends payment instructions to the settlement bank
exchanges, and the OCC also monitor market participants
The netting is done on a multilateral basis; i.e., the status
in respect to capital adequacy and other financial require-
of all of a clearing member’s holdings in the options
ments. The OCC is a part of the information-sharing
market is taken into consideration in arriving at the daily
arrangement among all seven SEC-registered clearing net payment obligation to the OCC.
entities, as well as a participant in the pay-collect risk
information system operated by BOTCC.27 The OCC uses
a monitoring system to quantify the potential risk of each
The OCC has two different methods for calculating
clearing member under different market scenarios, in-
margin-one for options on equities and another for all
cluding large price movements. The system evaluates the
other types of options (foreign currency, government
risk in participant’s stock, options, and futures positions. securities, or stock indexes). In both cases, the margin
required from the writer of an option is equal to the current
The OCC’s second line of defense against clearing market price of the option, plus a cushion to cover the risk
member default is the margin that the clearing members of a change in the current market price. But for all
have on deposit. If this is insufficient to cover the default, non-equity options, as well as all options and futures
the OCC can turn to its guarantee fund, made up of cash contracts cleared by the Intermarket Clearing Corp., the
and government securities.28 In the event of a default by OCC uses the Theoretical Intermarket Margin System
a clearing member, after closing out the defaulting (TIMS). TIMS evaluates each clearing member’s overall
clearing member’s positions, the OCC follows five steps risk profile and then sets the total margin owed. The OCC
to cover any residual liability from a default: was the first clearing organization in derivative markets
to change from a fixed or flat rate of margining (per
● First, any margin that the defaulting clearing mem-
contract) to highly sophisticated computational methods.
ber has on deposit with the OCC is applied towards Rules have been submitted to the SEC to expand the use
the liability of the default. of TIMS to include setting the margin on equity options.
● Second, if that amount is insufficient, the OCC takes
the defaulting clearing member’s contribution to the
guarantee fund and applies it towards the liability of The CFTC and the SEC have approved applications
the default. from the OCC and the CME to allow cross-margining of
● Third, if that amount is still insufficient, the OCC stock index options, futures, and options on futures for
may use its guarantee fund to cover-whatever portion proprietary trading accounts of clearing members. Cross-
of the liability is outstanding.29 margining between the CME and OCC started in October
● Fourth, if that still isn’t enough to cover the full 1989.31 OCC also offers cross-margining through an
liability, the OCC has the right to assess its members agreement with its affiliate, the Intermarket Clearing
for the remaining amount of the liability. 30 Corp. (ICC). The ICC clears trades for the New York
● Finally, the OCC, like the NSCC and futures clearing Futures Exchange, the Philadelphia Board of Trade,
organizations, may also take legal action as a creditor Amex Commodities Corp., and the Pacific Futures
to recover any sums that are owed by the defaulting Exchange; therefore, OCC members can use their hold-
clearing member. The amount that can be recovered ings on those exchanges to offset the status of their open
in this way is limited by bankruptcy law. positions at the OCC.

At the end of each trading day, the OCC has an The extent to which OCC and ICC offer cross-
overnight processing cycle during which it calculates the margining is however limited. The CFTC, concerned
net amount which each member either owes or is owed. about safety, market stability, and liquidity, has not

zTRob~ Woldow, “~earan ce and Settlement in the U.S. Securities Markets,” February 1989, expert paper contributed to O’JX’S contractor repom
Bankers Trust Co. report, op. cit., footnote 1.
zWhe total amount required in the guaranteed fund is recalculated mont.hly. As of December 1989, the guarantee, or clearing fund, PIUS a 1~ p~ent
..
muumal additional assessment for which OCC clearing members are unconditionally liable, was about $450 million. The amount of the fund varies in
proportion to the amount of clearing members’ liability. It is always equal to 7 percent of the average daily aggregaternarginrequirements of all clearing
members in the previous month. Each clearing member must contribute an amount equal to his pro-rata share of outstanding contracts in the previous
month.
z~e OCC has r~enfly amended its rules to include using itsown retained eh gs at the discretion of its Board of Directors.
%Iot all U.S. clearinghouses, however, have these assessment powers. See Bankers Trust Co., op. cit., footnote 1, vol. 1, p. 137.
Slsee John~att and James M. Kus~sch ctC1~ance and Settlement of D~vative FinancW ~s~ents,” April 1989; and John P. Behof, “Issue
Summary: Intermarket Cross-Margins, for Futures and Options,” The Federal Reserve Bank of Chicago, May 1989. Both are expert papers included in
the OTA contractor report by Bankers Trust Co., op. cit., footnote 1.
92 ● Trading Around the Clock: Global Securities Markets and Information Technology

approved expansion of cross-margining beyond proprie- certificates by permitting paperless transfer of title. This
tary accounts of major market-makers.32 system, TAURUS, is scheduled to be introduced in phases
beginning in 1991 and to be fully operational in 1993.
The OCC has approximately 190 clearing members.
The clearing member brokerage firms transact business The clearing and settlement process is managed by the
for their proprietary accounts, other brokers who are not ISE for all of its member firms. It is a two-part process
clearing members, and institutional and retail customers. consisting of a trade-matching system (called the Check-
The link between OCC and its clearing members is ing System) and a computerized settlement system,
automated: OCC requires that all members submit TALISMAN (Transfer Accounting and Lodgement for
post-trade information through OCC’s on-line Clearing Investors, Stock Management for Principals), introduced
Management and Control System (C/MACS).33 in 1979. TALISMAN settles securities trades between
The OCC allows its members to choose from a ISE members, including centralized routing of the securi-
selection of designated settlement banks. There are ties to the registrars for transfer of title.
currently 16, but the OCC is flexible and may designate
Trade settlement in the U.K. equities market usually is
a member’s primary banking institution (concentration
scheduled for the sixth business day after the end of each
bank) as an approved settlement bank. The OCC main-
2-week dealing/trading period (also known as the account
tains accounts at each of these settlement banks, and
period); all trades done during the 2-week account period
instructs the banks on each trading day as to the debits and
are scheduled to settle on the same day. Trading firms
credits that are to be made to the OCC’s accounts and
have the option of settling their trades on a schedule other
those of the clearing members.
than the account period, if this is agreed upon by the
There are controversial proposals to institute futures- trading parties. This can occur any time after the second
style margining for options, which seem to have support day following the trade (T+2), but this is rare.
recently. These are discussed in a forthcoming OTA
report on domestic securities markets. At the end of the trading day, member firms enter the
day’s trade data into the ISE’s Checking System either
Clearing and Settlement in the directly through a PC data transmission to the Exchange’s
34 computer, or by delivering a computer magnetic tape to
United Kingdom the nearest Stock Exchange Centre. The Stock Exchange
computer validates and compares all trades. Unmatched
The International Stock Exchange trades then have to be resolved, amended or canceled. For
The International Stock Exchange of the United TALISMAN eligible securities,36 the selling broker must
Kingdom and the Republic of Ireland Limited (ISE) in obtain from its customer, or its own inventory, the actua1
London, also operates exchanges in Belfast, Birmingham, share certificates and a signed TALISMAN Sold Transfer
Dublin, Glasgow, and Manchester/Leeds. It trades U.K. (TST) form, which authorizes the transfer of the security
equities, gilt-edged securities,35 and other fixed-income title from the current beneficial owner to SEPON (the
instruments, international equities, and options. The ISE’s nominee name) .37 The paperwork which includes
average daily trading volume from January to September the certificate, the TST, and a control document called the
1988 was 31,213 trades. (See ch. 3 for a detailed Sale Docket, after being properly signed, is then deposited
description.) at the nearest ISE TAMS MAN Centre.
The ISE settlement system is undergoing a transition. ISE staff verify the documents and record the deposit
Today it is still primarily paper-based, but there are plans on the computer. The security certificates and other
for an electronic depository to eliminate the need for documents must then be sent to the company registrar to

3~~ on ~tmiew by ow Sm with senior CITC ofllcials, Octobm 1989.

33~tt md Kustuscb op. cit., footnote 31.
~Muchof thernaterial in this section is based on an expestpaperwrittenby the ISEfor the OTAcontractorreport: Bankers Trust CO., op. cit., foo~ote
1.
sSGilt.~g~ ~~ties ~ debt ~~ents ism~ by the U.K. ~ve~ent. The= st~ks pay a fm@ variable or tidex-w~ rate Of hl@lXt, ~d
are co~idered risldree since their interest and capital are guaranteed by the government.
36Some Othm, non-~ISm se~emmts can ~ occw at tie ISE through physic~ defiv~ and pa~nt, Stice the ma- Systim Op~t~
independently from ‘I14LISMAN, ewm securities which am not Z4LISMAN-eligible can be validated and matched by the Checking System. But after
securities trades are matched, the ISE offers a central physical delivery area that allows such settlement among brokers to occur in one central place.
The Stock Exchange’s Central Stock Payment Department takes in securities from sellers and delivers them to the buyers. At the same time, it takes
the paynient from the buyer and gives it to the sellm. This is a man~ labor-intensive process.
qvAnofieeis apnorcompny~whose _eWfitiesm~ldor@~ onbehalfof ~oth~~mn orcompanywhois thetrueowner. SEPON
stands for Stock Exchange Pool Nominee. This is the ISE’S limited liability nominee company in whose name TALIS W-eligible securities are held
prior to settlement.
 Appendix--Clearing and Settlement in Major Market Countries ● 93

transfer the share registration from the customer’s name TALISMAN computer system keeps track of each
into the name of SEPON. The ISE’s broker/dealers and member’s payment obligations. These payments are
market-makers who maintain trading accounts within netted each day so that each member need only make or
TALISMAN can, through this SEPON-nominee account, receive one payment a day at the nearest TALISMAN
legally hold stock in uncertificated form. The recording Center. “Outside TALISMAN” means that trading
into SEPON must occur before any stock exchange parties maintain their own payment records and eitherpay
TALISMAN settlement can take place. the counterpart directly or deliver a check to the Stock
Exchange’s Central Stock Payment Department, to be
When broker/dealers and market-makers trade for their passed on to the selling party. Cash settlement occurs
own accounts, or act as principals, TALISMAN effects a when the trading parties agree to settle their trade on a
simple book-entry transfer of title without any need for
different schedule from the official account period, the
transfer forms or certificates, Approximately 7,000 secu-
day after the trade for Gilts and on the second day after the
rities issues can be settled through TALISMAN, most of
trade for equities.
the securities registered in the United Kingdom and
Ireland. Generally, payments for stock exchange trades are
This clearing and settlement process does not apply to made by check in British pounds, Irish pounds, or U.S.
all of the financial instruments traded on the ISE. Options dollars. Approximately half of the brokers make sterling
are cleared and matched by ISE, but are settled through payments through CHAPS, London’s interbank elec-
the International Commodities Clearing House in Lon- tronic payment system. The rest use London’s Town
don. U.K. Government gilt-edged stocks, also traded on Clearing bank checks.
the exchange, are validated and matched through the The ISE still has a fragmented and largely paper-based
ISE’s checking system, but settled through the Central settlement system. TALISMAN capability alone is inade-
Gilts Office.38 Foreign equity trades are matched through quate to support a major financial center. There are plans
an on-line comparison system called SEQUAL, 39 then to establish a paperless settlement system, called TAU-
settled by the broker independently of the ISE, in the RUS, an electronic depository service, to enable members
security’s home market. to keep their securities in dematerialized40 form with
The ISE does not take counterpart positions to trades. book-entry transfer of title on settlement.4142 The ISE
Market participants are not given a guarantee that the also plans to move towards a rolling settlement cycle to
trade will settle, only that if securities are delivered, then replace the existing 2-week trading account period with a
either payment will follow, or the securities will be further 6-day settlement period.43 One issue that remains
returned. The ISE’s services traditionally have facilitated under discussion is how the ISE would be able to assure
the post-trading processes for its members only. How- listed companies that they would still be able to quickly
ever, through the recent development of Institutional Net identify and communicate with their shareholders.
Settlement (INS), the ISE has begun to coordinate
institutional customer settlements as well.
The International Commodities
Payment on the settlement date may be through Clearing House (ICCH)
TALISMAN, outside TALISMAN, through cash settle-
ment, or through the Central Gilts Office, depending on ICCH 44 is an independent clearinghouse which pro-
the type of security and the preference of the TALISMAN vides matching, clearing, settlement, delivery management,
participants. “Through TALISMAN” means that the and trade guarantee services for five futures and options

ss~e Centi mts Office is a service jotitiy developed and funded by the Bank of England and the ISE for the settlement of U.K. Government
obligations.
39- provid~ by the ISE, but different fhm tie ~~ syst~
@Delnateri@ed Cetilcates of ownership are those that no longer have paper certificates and exist only as computer entries.
AlmURUS will, h its titi~ stiges, COV~U.rC. equities. The Centnd ~ts offke already in operation is a fully dematerialized el=~otic depositow
for U.K. Government Issues or Gilts.
A~mn~on is p~m~ @ ~ ism~ by s~~~r 1990 specifying TAURUS requirements, ~d *K P~ciP~ts to ~gin ~eir
implementation work for the introduction of TAURUS. “The ISE Announces Detailed Plans for the Future of Settlement in the United Kingdo~” ISE
News Release, Mar. 9, 1990. These plans are described in “A Prospectus for Settlement in the 1990s,” ISE, March 1990, and project a date of March
1991 for the completion of the infrastructure, which includes: the use of the Institutional Net Settlement service, and the phased replacement of magnetic
tape and paper transfer systems; the phase-in of book entry transfer, i.e., dematerialization of certificates, between October 1991 and December 1993;
and the introduction of an initial 5-day rolling settlement (to be shortened to 3 days later) and a full delivery v. payment system by October 1992.‘Ihese
steps are projected to save over f200 over a I@year period and sre consistent with the Group of Thirty’s recomxntmdations.
43~e tem ~~m~ ~~aent~~ mm ~ tie ~~aent &te is ~ways tie -de &te plus a sp~ific number of &ys. For example: T+3.
%umnary of expert paper by the ICCH for the Bankers Trust Repo@ “Study of International Clearing and Settlement” op. cit., footnote 1.
94 ● Trading Around the Clock: Global Securities Markets and Information Technology

exchanges in London. 45 The ICCH also provides clearing ICCH becomes the counterpart to every trade. ICCH
and settlement services to exchanges in New Zealand, further decreases risks to clearing members because it
Australia, Hong Kong, Kuala Lumpur, and Paris. It performs this function across multiple exchanges, netting
provides electronic screen trading systems for three members’ positions out into a single margin and settle-
exchanges; the New Zealand Futures Exchange, the Irish ment figure. This process is called multilateral netting by
Futures and Options Exchange, and the London FOX. novation. Usually the clearinghouse makes one margin
call every day before the start of the day’s trading, but in
ICCH is organized into two divisions: the Recognized periods of high market volatility, it reserves the right to
Clearing House, which handles the London-based opera- make more frequent intra-day variation margin calls. For
tions; and the ICCH International Financial Markets, example, on October 19, 1987, ICCH made four intra-day
which is responsible for international operations and
margin calls.
computer systems. The clearinghouse is owned by a
group of six shareholder banks,46who are the ultimate
guarantors of the clearinghouse’s obligations. Ownership ICCH accepts approximately 30 banks as settlement
status has implications primarily in the case of default by banks, including some foreign banks’ branches within the
a clearing member. In a clearinghouse owned and City of London. Each clearing member typically has at
operated by one exchange, all of the clearing members are least two sterling-denominated accounts at his settlement
ultimately liable for the obligations of a member who fails bank; one for segregated funds (e.g., those of individual
to perform. In the case of an independent clearinghouse, investors) and one for non-segregated funds (in-house,
such as ICCH, the ultimate liability of meeting a failed non-clearin g members, and non-segregated customer
member’s obligations rests with the shareholders, not funds). In addition, each member may hold foreign
with the clearing members. This raises the question of currency denominated accounts at the settlement bank to
potential conflict of interest among shareholders, clearing cover margin and settlement payments in Deutsche
members, and customers of clearing members. 47 marks, yen and U.S. dollars. The clearinghouse also keeps
accounts at each settlement bank, multiple accounts if
ICCH has approximately 200 clearing members in different currencies are involved.
London who trade at the five exchanges. These members
act as clearing agents for their own in-house trades,
customers’ transactions and non-clearing members Every morning at 8 a.m., messengers deliver printouts
trades. While trading is primarily by means of open outcry to each clearing member’s settlement bank detailing daily
on exchange floors, once a trade is struck, both the buying margin payments and credits. The banks have until 10
and the selling party are required by the exchanges to a.m. to credit or to debit the accounts of members. The
enter the trade data into the exchange’s computer banks use ICCH’s “Protected Payment System,” which
matching system within a specified time. The exchange functions in the same way as third party debit authority in
system matches the trade data and makes the matches the United States.49 If a bank has any problems in meeting
available on-line to the floor brokers for confirmation. A a margin call for a member, the bank must notify the
matched and confirmed order is sent immediately by data clearing house by 10 a.m. One of the risks of the margin
transmission feeds to the ICCH’s system for settlement. 48 settlement is that banks do not have to commit payments
to the clearinghouse on behalf of a member until after
Trade data is processed by the clearinghouse on a trading begins in the morning. The opening hours vary at
continuous basis rather than in a batch cycle at the end of each exchange, but the London International Financial
the day. Members can monitor their settlement positions Futures Exchange for instance, starts trading at 8:15 am.
through the management information system at any time This could result in a member accumulating adverse
during the day. At the end of a trading day, members can trading positions before yesterday’s margins have been
look at a terminal to see what their initial and variation committed to by the settlement banks. It could become a
margin calls will be on the following morning. problem during periods of high-market volatility.
Asney Ue the Baltic Futures Exchange (which trades contracts for cattle, pigs, soybean meal, potatoes, and freight~dexes); the ~t~tio~
Petroleum Exchange (which trades contracts for gas oil, crude oil, heavy fuel oil, and leaded gasoline); the London Futures and Options Exchange (FOX)
(which trades contracts in coffee, cocoa, and sugar); the Imndon International Financial Futures Exchange (IJFFE) (which trades a range of contracts
including currencies, interest rates, bonds and indexes); and theI.xmdon Metal Exchange (which trades contracts foralumin w lead, copper, nicke~ zinc
and silver).
AGNatio~ Wes-ter, Barclqrs BarIQ Lloyds Ba@ Midland B@ Royal Bank Of !lcotkmd, ad s~~ ~e~
47~ 1989, a cl- me-r defa~t ~-~ on the NW Z-rid Futures fic~ge. cmtom~ of the other clearing members wme subjected tO
an invoicing-back procedure which in some instances, created losses for them.
48Wi~ tie exception of the a~c~~ exc~g~ (the B~tic Futures Exc~nge and FO~, ~ch of the exc~~ operates its own llWChiIlg iUld
confhmation systems. The agricultural exchanges depend on ICCH for both trade matching and confiition.
4~e Cle-ouse cm tell tie set~aentba~ to move money from amember’s ac~~tatthe b~ to the cle~ghouse’s account at the Setdment
bank without a new authorization from the member.
 Appendix--Clearing and Settlement in Major Market Countries ● 95

Since ICCH is a net margin clearinghouse, each handled by the same organization, but the different
morning it submits one number to the appropriate instruments are cleared separately. In the United States,
settlement bank for either payment or credit of non- by contrast, equities, futures and options generally are
segregated accounts and segregated accounts. Collateral, traded on separate exchanges as well as processed by
such as a letter of credit, can be pledged to the different clearinghouses.
clearinghouse as a guarantee against trading on multiple
exchanges. If the ICCH did not net margin requirements The Japanese futures market adheres to the mark-to-
across these exchanges, this practice would increase market principle in requiring payment of margin, but
settlement risk. As it is, the member has the benefit of payment is not due until the third day after the trade. Japan
incurring reduced payment risk and cost. ICCH accepts and the United States differ in the types of collateral
letters of credit (also known as bank guarantees), cash and which are acceptable as margin payments; Japanese
U.K. Treasuries as collateral for margin payments. It is clearing houses do not accept bank letters of credit as
moving towards accepting U.K. Gilts and U.S. Treasury collateral, but they do accept listed securities. The reverse
Notes as collateral but there are some legal issues that is true in the United States.52
must be worked out; both of these instruments are held in
decertified form in depositories and can therefore not be In Japan, there are many unwritten rules or protocols
physically delivered as collateral to the clearinghouse. that must be followed in the clearing and settlement
The possibility of pledging these securities on behalf of process. 53 The Japanese Government, especially the
the clearing house is being investigated. Ministry of Finance (MOF), has a much stronger influ-
ence on the day-to-day management of the brokerage
business than do regulatory agencies in the United States.
Clearing and Settlement in Japan But more importantly, the Japanese cultural emphasis on
In many ways securities markets in Japan and the the importance of honor and conformity, concepts which
United States are similar, in other ways they are very relate to the reputation and behavior of companies and
different. Both countries have multiple equity exchanges, their employees, help to explain the punctual settlement
and in both, one or two of these exchanges handle most practices in Japan. Trades do not fail in Japan, generally
of the total trading volume 50in securities. In Japan, this is speaking, because it is dishonorable not to meet one’s
the Tokyo Stock Exchange. However, Japan’s over-the- obligations. Further, those who do not meet their obliga-
counter market is minuscule compared to that in the tions risk being put out of business.54
United States. In contrast with the well-established
national depository system in the United States, there is Although there is not a widespread concern in Japan as
no national, central depository in Japan, but one is now to the possible volume-induced stress on the clearing and
being established. settlement system, Japan’s financial services industry
would like to see some improvements in it. Issues which
In Japan, as in the United States, the clearing and are currently under discussion include:
settlement process varies according to the type of
financial instrument traded (i.e., futures, equities, op- . The reduction of physical movement of securities: in
tions). 51 To a greater extent in Japan, different financial addition to Japan’s setting up a central depository for
instruments are traded on the same exchanges, and the securities, the Bank of Japan is creating an on-line
clearing of both securities and derivative products are depository for Japanese government bonds.55

~&x ch. 4 for detailed description of the Tokyo Stock &change.

sl~e OptioIIS ~ket in Japan had until recently been a private, off-exchange, large volume market. In June 1989, options m tie Nikkei 225 ~d=
began trading on the Osaka Stock Exchange.
52~ tie Ufitd Stites, however, fi~es ~le~@ome5 ~ve be~ to view letters of credit u a less d~irable fo~ of cowter~. Securities (with the
exception of U.S. Treasury obligations) are not accepted as collateral byU.S. futures clearinghouses. They are, however, accepted by the Options Clearing
Corp., which handles the clearing forall exchange-traded options in the United States.
53For e~ple, protocol dictates that delivering an institutional trade and collection of paymentbe done by pr-~ement o~Y.
54”If shares are not available for delivery in Tokyo, a broker issues a letter of guaranty, essentially a promise to deliver later, to its clients. The client
then pays the broker, with the knowledge that they own the stock and it will be delivered shortly. A safekeeping receipt is delivered on trade&te, with
the shares following when available. The Japanese allow the use of letters ofgusranty with domestic counterpardes, but acceptance for foreign
participants varies from one custodian to the next.” Quoted from Daiwa Securities AxnencaInc., “Viewpoint: Perception and Opinions of a Non-United
States Parented Firm Doing Business in the United States and World Securities Markets, ” Summer 1989, p. 4, contributed paper in OTA contmctor
report, Bankers Trust Co., op. cit., footnote 1.
55Nomura Securities, “The Securities clearing and Settlement System in Japaq” Februq 1989, contributed paper in OTA contractor report by
Bankers Trust Co., op. cit., footnote 1; Toshitsugu Shimizu, “settlement System of ‘Ibkyo Stock Exchange,” Oct. 5, 1988, ibid.; interviews with
Masayoshi Hamam and Toshitsuqu Shimizu of the Tolqo Stock Exchange, Mar. 8, 1989, Bankers Trust Co., op. cit. footnote 1; and IBM, “Study of
Clearance and Settlement for the U.S. Congress-OTA,” Aug. 1, 1989, also part of the OTA contractor report by Bankers Trust Co., op. cit., footnote
1.
96 ● Trading Around the Clock: Global Securities Markets and Information Technology

. Same-day funds: except for Japanese government day (3 days after the trade date), but the payment and
bonds, the settlement of all stock exchange trades in securities delivery processes are separate. JSCC is not
Japan is through checks, which do not clear until the involved in the payment process, which is handled by the
next day. Some risk could be removed from the TSE’s Clearing Administration Department; JSCC takes
settlement process if payment were to be made in care of the securities delivery. The transfer of title to
same day funds, via an electronic funds transfer securities is handled through JSCC’s computer Book
system. 56 Entry Clearing System and through physical delivery of
paper securities certificates.
The Japanese securities industry is also discussing
ways to facilitate cross-national border trading for both Neither JSCC nor the Clearing Administration Depart-
Japanese investors and foreign investors. Some possible ment take the counterpart position to trades. Nor are any
improvements include: other formal guarantees made by either organization to
● Immobilization of securities in their home market: assure that the payment and securities delivery obliga-
the Japanese securities industry supports this, as well tions of settlement will be met.62
as the creation of bilateral and possibly multilateral All equities are processed by JSCC’s computerized
linkages among depositories and clearinghouses.57 Book Entry Clearing System and are settled in one of four
● Elimination of Depository Receipts (DRs): the Tokyo ways:
Stock Exchange advocates this as part of immobiliz-
ing securities.58 1. “Regular way settlement”: normally, on the 3rd
● International harmonization of settlement times; as day following the date of the trade; 99 percent of the
noted, equity settlement in Japan takes 3 days, and in TSE’s stock transactions are settled in this way.
the United States 5 days. 2. Cash transactions: settlement is on the day of the
trade (T+O); however, if both parties agree, settle-
The Tokyo Stock Exchange (TSE) ment can be on the day after the trade.
Japan Securities Clearing Corp. (JSCC)—The TSE 3. Special agreement: settlement is scheduled at the
has a division known as the Clearing Administration seller’s option, for a specified day within 15 days of
Department, which is the planning and rule-making body the trade date. This method is primarily used when
for all matters concerning clearing and settlement.59 It the counterparties to the trade are geographically
supervises the overall process, but the bulk of the separated from each other by a considerable dis-
day-to-day clearing and settlement process is entrusted to tance.
the Japan Securities Clearing Corp. (JSCC), a wholly 4. When issued: this method of settlement is used for
owned subsidiary of the TSE. All of the approximately purchases of securities which either have not yet
120 members of the TSE are regular members of JSCC, been issued, or, for some other reason are not yet
so there are no exchange members who are not also available for delivery to the buyer. Contracts for
clearing members. All must maintain a clearing office in these types of securities trades are settled on the 4th
Tokyo and a banking relationship with each of the 13 business day after the trade. After the shares have
approved clearing banks.60 been issued the stock exchange determines a date
after which “when issued” transactions may no
JSCC settles cash-market equity trades (both domestic longer be performed.
and foreign), a variety of bond trades, and futures
contracts (TOPIX)61 and U.S. government bonds traded Less than 1 percent of the transactions at the TSE end
on the TSE. For equities trades, cash settlement and the in a failure to deliver shares on settlement day. If,
transfer of shares from seller to buyer occurs on the same however, there is a default on either payment or delivery

S6SW IBM Aug. 1, 1989, op. cit., footnote 55.

sT~ Japm s~ties CIWUI@ COrp. (JSCC), which clears transactions for the Tc@o Stock Exchange @sE), c~entiy maintains linkages with
depositories and/or clearing houses in nine countries. See interview with Masayoshi Hamana and paper by T@hitsugu Shimuzu, op. cit., footnote 55.
SsDqository R~eip@ me domestic rweipts for the shares of a foreign-based corporation which are on deposit inabankvaulc or ac~tidmsitory,
in that corporation’s domestic market. A DR for a foreign stock can be purchased in a domestic market which does not list the underlying stock itself.
Ibid.
59stw~ on~ To@o [email protected]&c~e MC traded by ~o ~~entmc~odso ‘rhe 150 most active stocks me trad~~~y on the -c@ f100r. The
TSE recently announced that it is developing an electronic order book for these 150 issues which may be in use in late 1990. All other domestic and
foreign stocks are traded through CORES, the Computer-Asisted Order Routing and Execution System. See Ch. 4: Americans Compefitorsin Securities
Trd”ng. AISb see Harnana and Shimimq op. cit., footnote 55; and IBM repo~ op. cit., footnote 55.
me TSE rotates among these banks on a month-to-month cycle.
61~~T0p~~J me ~~o Stwk price~dexfi~es con~cts, Jap~’s equivalent of the Standard and Poor’s 500 index futures contracts onus. stocks.
bz~e TSE does provide for interest and peualties on those OCCaSiOXld MM tit f~.
 Appendix--Clearing and Settlement in Major Market Countries ● 97

of securities, the TSE requires that the trade be cleared or either receipt or delivery of securities in about four-fifths
canceled within four additional business days.63 of all transactions.64

For “regular way” settlement, procedures differ ac- Depository Functions-Although currently clearing
cording to whether the trade was done on the floor or and settlement is done in Japan without a central
through the CORES (automated execution) system. For depository, this is expected to change in October 1991, in
floor trades, specifics of the transaction are written on respect to domestic stocks. The central depository to be
trade slips which are transmitted via optical character set up by financial services industry and the government
reader and computer terminals to the member firms which regulatory agencies is to be called the Japan Securities
are counterpart to the trade. As for electronic trades, the Depository Center (JASDEC).65 All the details have not
trade data is automatically transmitted to the counterpar-
yet been worked out, but the plan is for JASDEC’s
ties. Trade data is compiled overnight by computer and relationship with the JSCC to be similar to that between
transmitted to the JSCC before the exchange re-opens the
the National Securities Clearing Corp. (NSCC) and the
next morning. If either counterpart finds an error,
Depository Trust Co. (DTC) in the United States.
corrections must be made by contacting the TSE by the
Alternative ways to streamline the custodial and deposi-
afternoon of T+l.
tory aspects of clearing and settlement for foreign stocks
Settlement is always on a net basis, in respect to both
are being discussed. JSCC has recommended that it
the payment and securities. Accordingly, by the morning
increase the number of its linkages with foreign clearing
T+2, JSCC advises the counterparties on their net
houses and depositories.
settlement obligations. By 4 p.m. on T+2, each net seller
firm advises JSCC as to how it intends to provide shares Currently, JSCC’s book entry clearing system transfers
for settlement (i.e., book entry or physical delivery), and TSE-listed stocks directly between accounts, but a major
each buyer firm advises JSCC as to how it wants to problem is that this is done on the basis of stock exchange
receive the shares due to it. The seller delivers securities rules, not on the basis of law. In order for re-registration
by means of either the JSCC’s computer book entry to occur before each record date, JSCC returns the
system or through the physical delivery of certificates by deposited share certificates to the shareholders (it will also
mid-day on the third day following the trade. Payment is do so at any time its members request it). JASDEC’s
also made on T+3, but is by bank check (next day funds) Central Securities Depository System will immobilize
rather than electronic funds transfer. physical certificates, providing for book entry share
transfer facilities, and tracking real ownership. 66 The
Since finality of settlement is thus delayed on the securities that will be eligible for such processing are
payment side, this settlement cannot be said to offer true listed share certificates, OTC share certificates of the
delivery versus payment (simultaneous settlement of the Japan Securities Dealers Association (which is develop-
delivery and payment obligations of a trade). On the ing a new electronic market, JASDAQ, modeled on
morning of the fourth day following the trade, the NASDAQ), and warrants listed on stock exchanges.
payment obligation for settlement is netted into a single Participants in the central depository will be required to
. obtain written permission from their clients in order to
immobilize share certificates, and then will be responsible
Most TSE transactions do not involve physical delivery for opening and maintaining deposit accounts for the
of certificates. In only 15 percent of all TSE transactions client. Share certificates will be transferred to the name of
do both buyer and seller request that the actual certificates the central depository and kept in joint custody. Every
be part of the settlement. In 41 percent of TSE trades, both Japanese exchange and clearing house will open a share
counterparties request settlement through JSCC’s book account at JASDEC. JASDEC will also handle book-
entry system. The result is that book entry is used for entry deliveries of over-the-counter securities.
63rf ~~ is ~ defa~t on the securities delivery, the seller may issue a “due bill” to the TSE (an IOU, actually a bank check for the money amount
of the failed trade). The due bill is deposited with the TSE until the seller’s obligation has been met. If the seller should default on the delivery, theTSE
will turn the due bill over to the buyer. The due bill is a contractual agreement between the seller and the TSE, and is covered by exchange rules and
regulations and defaulting sellers are subject to TSE penalties.
isasti op. cit., footnote 56.
6S~ $$~w CO~ g Central Depository and Book-Entry Deliveries for Share Certificates and Other Securities” which authorized the creation
of JASDEC was passed in May 19S4. Development work on JASDEC began in December 1984; the target date for implementation is October 1991,
66~thiswy, the services provid~ at JASDEc will be similar to those provided by the XMJRUS @nmsferand Auto~t~Re@t@ion of unc~~
Stock)”book-entry computer system used by the International Stock Exchange in Ixmdon.
98 ● Trading Around the Clock: Global Securities Markets and Information Technology

67
The Osaka Securities Exchange (OSE) traded on the Osaka exchange. Eurodollars, yen, and
Euro-yen contracts are traded on the newly created Tokyo
OSE has 94 exchange members and an additional four International Financial Futures Exchange (TIFFE). Trad-
non-member special participants, admitted in order to ing for both the latter contracts has been computerized
trade in futures contracts. Unlike the TSE, the OSE trades since it began, in October 1988. TOPIX futures contracts
options as well as securities and futures. The options are are traded through the TSE’s CORES-F system.
based on the Nikkei 225 index; trading began in June,
1989. Whereas open positions in the Nikkei 225 Stock
Average are settled in cash on the last trading day of the
Clearing and settlement of options contracts is handled contract, open positions on the last trading day of the
by the OSE’s own clearing department. All members of OSF50 contracts are settled by physical delivery of shares
the OSE are also clearing members. The process at the of the 50 underlying stocks. The OSE’s clearing depart-
OSE is similar to that at the TSE, with a few notable ment requires both the buyer and the seller of an OSF50
differences. First, all trade data comes in via trade slips or Nikkei 225 futures contract to deposit as initial margin
and optical character recognition (OCR) reader the OSE a minimum of 9 percent71 of the sales/contract value (with
does not yet have electronic trading, although it will begin a minimum of 6 million yen). One third of the initial
sometime in 1990. Secondly, all equities are settled margin payment must be paid in cash. After the first day
through physical delivery instead of by book-entry of the contract, additional margin is owed depending on
transfer of title. The OSE does, however, plan to make use price fluctuations in the market, after daily marking to
of the JASDEC depository and custodial capabilities, market. Additional margin is due when a loss due to
when it opens, but will retain its own clearing department. adverse market price fluctuations exceeds 3 percent of the
sales or total contract value.
Special Features of Japan’s Markets
TOPIX futures are settled in the months of March,
Japanese Banks and Settlement-Japan does not now June, September, and December. Customer margin re-
offer “delivery versus payment” service, because stock quirements are similar to those at the OSE for OSF50
exchange payment is generally made through checks contracts, an initial margin of either 9 percent of the value
which do not clear until the next day. This poses a risk for of the transaction or 6 million yen. Members must also
the seller, since there is always the possibility that a check pay margin of 6 percent or more of the price of the
may bounce. contract.
The exchanges decide which banks are clearing banks Government bond futures are settled on the 20th of
(TSE has 13 clearing banks, OSE has 8). Clearing March, June, September and December. Banks and
members must maintain an account with each of those non-TSE member securities companies may use accounts
banks, but do not give their banks third-party debit at JSCC to clear Japanese Government futures contracts.
authority (i.e., blanket authorization to debit a clearing
member’s account at the instruction of the clearinghouse). The TSE and the OSE accept as collateral to meet
The exchanges receive payments from members and margin requirements for futures any of the following:
deposit them into an exchange account at one of the cash, any securities listed on any Japanese exchange,
approved banks,68 collecting all monies owed to it for that stocks registered with the Japan Securities Dealers
day before disbursing money from the same bank account Association, or beneficiary certificates of the securities
to members who are net sellers. Both the TSE and the OSE investment trusts. Bank letters of credit are not accepted
set and annually review individual payment limits for as collateral. Payments are due from clearing members for
each of their members; within these limits the member the netted position of each type of futures contract. The
may present uncertified checks for settlement obligations. Osaka Securities Exchange maintains a Settlement Fund
and a Default Compensation Reserve Fund System which
Futures Contracts69--TOPIX and Japan and U.S. cover participants against the default of other exchange
government bond futures contracts are traded on the members. These funds are for the trading of all instru-
Tokyo Stock Exchange. Osaka Securities Exchange Stock ments on the Exchange, including futures contracts. The
Futures (OSF50)70 and Nikkei 225 futures contracts are TSE also has a guarantee fund, which totals 5 billion yen.
GTrnfomtion in this section is based on the IBM repo~ op. cit., footnote 56, on the response to questions posed to Mr. Y05hioh of the O* Stool
Exchange by OTA contractor, Bankers Trust Co., op. cit., footnote 1, and an interview by OTA contractor, Bankers Trust Co., with Messrs. Yoshibzuu
Oritani, Eiji Hirano, and Iwao Kuroda, Bank of Japan, March 1989.
GsTheexc~ges~~ acco~ts at eachof the clearing banks, although only one is used at any one time. The exchanges mtatewh.ichof me cIX
banks they use according to a defined schedule (i.e., the OSE rotates every 10 days; the TSE, once each month).
Gwo~tion supplied by the TSE and the OSE, in OTA contractor report by Bankers Trust Co., op. cit.,foO~Ote 1.
T~e OSFSO is almost a dormant market.
TIU.S. fi~es margins are generally 3 to 5 percent.
 Appendix--Clearing and Settlement in Major Market Countries ● 99

International Trading72—The TSE currently lists 120 domestic clients, because information must pass through
foreign stocks. JSCC advocates building and maintaining a series of intermediaries. So, at least with linkages, it is
custodian relationships in the country where these securi- easier for the nonresident to deposit securities locally in
ties were issued. Clearing and settlement communications the home country, where most custody is. This eliminates
can then be handled through business linkages (i.e., a risk for the TSE-member broker, who remains obligated
dedicated communication lines) between depositories and to settle on T+3, and otherwise might have difficulty
clearing houses. Trades in foreign securities listed on the receiving the physical shares from clients in time for
TSE are cleared through JSCC’s book entry system. They settlement.
are held by JSCC in the issuer’s home country, either
through a link to that country’s depository, or in a custody U.S. securities comprise 70 percent of the foreign
account through a bank in that home country. JSCC has securities traded on the TSE. The TSE has a special
linkages for this purpose with Australia, Canada, the arrangement with the International Securities Clearing
Netherlands, Germany, France, Spain, Sweden, Switzer- Corp. (ISCC) in the United States, through which U.S.
land, the United Kingdom, and the United States.
shares traded in Japan are kept for JSCC by ISSC on
Both the TSE and the JSCC feel that there are deposit at The Depository Trust Co. (DTC) in New York
significant advantages to the book entry approach, City. In the same way, JSCC acts as a custodian for
combined with overseas custody linkages, because the Japanese securities which are being traded on some
efficiency of equity clearing is based on the ability of exchanges outside Japan. Currently, it provides this
investors to fulfill the delivery obligation by either service to depositories in the Netherlands and France and
book-entry receive or delivery on the settlement date is discussing with ISCC the possibility of acting as a
(T+3). Settlement of transactions on behalf of non- depository for Japanese stocks being traded by ISCC
residents is usually more complicated than settlement for participants in the United States.

Tz~o~tion in tb,is s~tion is based on a paper by Nomura Securities, in the OTA contractor report by Bankers Trust CO., op. cit., footnote 1.
Acronyms and Glossary

Acronyms
ACT —Automated Confirmation Transaction LIFFE —London International Financial Futures
[System] (NASD) Exchange
ADP —Automatic Data Processing, Inc. MATIF —Financial Futures Market (France)
ADR —American Depository Receipt MOF —Ministry of Finance (Japan)
AMEx —American Stock Exchange MONEP —Paris Options Market (France)
BIS —Bank for International Settlement MOU —Memoranda of Understanding
BOTCC —Board of Trade Clearing Corp. MSE —Midwest Stock Exchange
CBOE -Chicago Board Options Exchange NASD —National Association of Securities Dealers
CBOT —Chicago Board of Trade NASDAQ —NASD Automated Quotation system
CCITT -Comite Consultatif International Nikkei 225 —Nikkei 225 futures contracts (Japan)
Telegraphique et Telephon (International NSCC —National Stock Clearing Corp.
Telecommunications Union) NYMEX —New York Mercantile Exchange
—Commodity Exchange Act NYSE —New York Stock Exchange
CEDEL —Centrale de Livraison de Valeurs OCC -Options Clearing Corp. (U.S.)
Mobilieres OECD -Organization for Economic Cooperation
CFTC —Commodity Futures Trading Commission and Development
(U.S.) ONA -Open network architecture (of computer
CME -Chicago Mercantile Exchange systems)
CNs -Continuous Net Settlement OSE -Osaka Stock Exchange (Japan)
DTC —Depository Trust Corp. OSF50 -Osaka Securities Exchange Stock Futures
DVP -delivery-versus-payment (Japan)
EC —European [Economic] Community OTC -Over-the-counter
FIBv —Federation International des Bourses de PHLX —Philadelphia Stock Exchange
Valeurs PSE —Pacific Stock Exchange
—Federal Reserve Board (U.S.) —Postal, Telegraph, & Telephone
FRs —Federal Reserve System [Authority]
G-30 -Group of Thirty S&P 500 —Standard & Poor 500 Stock Index
GAO -General Accounting Office SCG —Securities Clearing Group
GM -General Motors SDF —Same-Day Funds
ICC —Intermarket Clearing Corp. SEAQ -Stock Exchange Automated Quotation
ICCH —International Commodities Clearing House system (London)
(U.K.) SEC —Securities and Exchange Commission (U.S.)
—International Futures Exchange of SEPON —The Stock Exchange POol Nominee (U.K.)
Bermuda SIAC -Securities Industry Automation Corp.
IOSCO —International Organization of Securities SICOVAM -Societe Interprofessionnelle pour la
Commissions Compensation des Valeurs Mobilieres
ISCC —International Securities Clearing Corp. SIMEX -Singapore International Monetary
ISE —International Stock Exchange of the Exchange
United Kingdom and the Republic of SIPA -Securities Investor Protection Act
Ireland (in London) SIPC -Securities Investor Protection Corp. (U. S.)
IS0 -Organization for International Standards SPAN -Standard Portfolio Analysis of Risk
ISSA —International Society of Securities SRO —Self-Regulatory Organization
Administrators T+l —Trade Date Plus One Day
ITS —Intermarket Trading System TALISMAN —Transfer Accounting and Lodgement for
—International Telecommunications Union Investors, Stock Management for
JASDEC —Japan Securities Depository Center (Japan) Principals (U.K.)
JSCC —Japan Securities Clearing Corp. TARS —Trade Acceptance Reconciliation System
KCBTCC —Kansas City Board of Trade Clearing (NASD)
Corp. TAURUS —Transfer and Automated Registration of
KV —Deutscher Kassenverein Uncertified Stock (U.K.)

-1oo-
 Acronyms and Glossary .101

TIFFE —Tokyo International Financial Futures Book-Entry: An item in a depository’s computer records
Exchange that identifies, or is used to transfer, ownership of
TIMS —Theoretical Intermarket Margin System stocks or bonds.
TOPIX —Tokyo Stock Price Index Futures Broker: A securities firm or individual that represents
TIMS —Theoretical Intermarket Margin System customers in transactions (i.e., trades as an agent). See
TOPIX —Tokyo Stock Price Index Futures “Dealer.”
Contracts (Japan) Bull Market: A rising market; that is, a market with
TSE —Tokyo Stock Exchange generally rising prices. See “Bear Market.”
UCC —Uniform Commercial Code (U. S.) Call: See “Option.”
Capital Markets: Markets where debt and equity securi-
ties are traded. Includes private placement as well as
organized markets and exchanges.
Glossary Capitalization (of an exchange): The total value of listed
Access Deregulation: Changes in national laws or securities.
regulations that open the counties markets, especially Cash Market: The market in which transactions are
membership on exchanges, to foreign participation. completed immediately and assets will be delivered in
American Depository Receipt (ADR): A receipt signify- return for payment; as contrasted with a futures market.
ing ownership of shares in a foreign corporation. Cash markets include organized, self-regulated ex-
Transactions are made in the ADR in lieu of transac- changes and over-the-counter markets for stock and
tions in the security, which is usually held by a trustee. commodities.
The ADR is usually issued by a foreign branch of an Churning: Excessive trading of securities or other
American bank. products by a broker or floor trader, usually in order to
American-Style Option: A put or call option that can be generate commissions. A form of market abuse.
exercised at any time before expiration; all listed Clearing or Clearance: The processing of transactions in
options are of this kind, including those on European stock, futures, or options markets, in which the buyer’s
exchanges. See “Option” and “European-Style Op- and seller’s records of a transaction are matched, in
tion. ” preparation for settlement. Clearing includes confirm-
Amex: American Stock Exchange, in New York, the ing the identity and quantity of the security or contract
second largest U.S. stock exchange. being bought and sold, the transaction price, date, and
Analog Signals: Resemblance or correspondence; used to identity of the buyer and seller. In some clearing
describe traditional forms of electronic information organizations, it also includes the netting of trades.
such as pictures, speech, or written and printed Clearing Member: A securities firm that is a member of
characters, as opposed to digitized information. both an exchange and its clearing organization; a
Arbitrage: The simultaneous or closely related purchase clearing member handles (for a fee) the clearing of
and sale of the same product or related products in transactions of other members of the exchange who are
order to take advantage of price differences between not clearing members, as well as its own clearances.
them (which are presumed to be unrealistic and Clearing Organization: An organization that handles
temporary). Arbitrage often involves stock and either clearing and (sometimes) settlement; clearing organiza-
futures or options; it may involve a basket of stock and tions do not exist in some countries.
a stock-index futures contract. Closing a Position: Eliminating an investment from
AURORA: An electronic system for the international one’s portfolio, either by selling it or (in futures and
trading of futures contracts being developed by the options trading) making an offsetting transaction—
Chicago Board of Trade; it is now to be merged with e.g., a purchase of a futures contract offsets the sale of
the GLOBEX system (see GLOBEX) but details have a futures contract.
not been worked out. Counterparty: Either party (buyer or seller) to a transac-
Bear Market: A market with generally declining prices. tion.
See “Bull Market.” Custodian: A bank or other financial institution that
Block: A large number of shares of a single stock; usually keeps stock certificates and other assets for a customer
defined as 10,000 shares or shares whose value is at (an individual, corporation, mutual fund, or pension
least $200,000. fund).
Bond: A debt security; a long-term promissory note Dealer: A securities firm or individual acting as principal
evidencing corporate or government debt, which pays (trading for a proprietary account) rather than as agent
interest to the holder. (trading on behalf of a customer). If a firm acts as
102 ● Trading Around the Clock: Global Securities Markets and Information Technology

principal in some transactions and as agent in others, ery in the future, at a specified price. Each party to the
it is called a broker/dealer. contract is obligated either to fulfill the terms of the
Debt Security: An instrument representing money bor- contract or to offset the contract by entering into an
rowed, such as a bond, a bill, a note, or commercial opposite transaction. The latter (the most commonly
paper. It specifies a fixed amount of money, a date or chosen alternative) can be done because the clearing
dates of maturity (repayment), and usually a fixed rate organization becomes one counterpart to all transac-
of interest or discount on the original purchase price. tions.
Delivery v. Payment: A settlement term, meaning that GLOBEX: An electronic system for international trading
delivery of a security requires payment at the same of futures contracts, developed by Reuters and the
time; in effect, a cash-on-delivery transaction. Chicago Mercantile Exchange, scheduled to become
Dematerialized: Existing only in the form of electronic operational in 1990-91.
records, in lieu of a paper certificate (e.g., a dematerial- Group of Thirty: An independent, non-profit association
ized security). of business persons, bankers,- and representatives of
Depository: Organizations that hold stocks and bonds for other financial institutions from 30 developed nations,
safekeeping, on behalf of their owners. who address major global financial topics at policy
Derivative Products: Tradable futures and options con- levels.
tracts for which the pricing depends on (i.e., is Hedge: Protecting one position by taking an offsetting
derivative of) the price of a specified asset, such as a position. Typically, one takes a position in a futures
stock, a commodity, or the basket of stock represented market opposite to a position in a cash market (a
in a stock index such as the Standard& Poor 500. commodity or stock market) in order to minimize the
Digitization of data: The translation of data from risk of loss from an adverse price change. An
traditional (analog) forms such as pictures or printed institutional investor may use stock-index futures to
figures and text to binary-coded electronic signals. hedge an indexed stock portfolio. Other means of
Dow Jones, or Dow Jones Averages: Market indicators, hedging include selling short, buying a put option, or
issued by the Dow Jones & Co., to indicate changes in selling a call option.
price of groups of stocks: for example, industrial, Index: A market indicator that represents the average
transportation, utility, and composite groups of stocks. price of a specific basket or portfolio of stock.
Efficient Market: A market in which the prices of Index arbitrage: The simultaneous purchase/sale of the
securities immediately reflect all available informa- basket of stock represented in an index (such as the
ion; for "free market” advocates, a market in which Standard & Poor 500) and of the stock-index futures
prices are relatively unloaded or “distorted” by contract for that index in order to profit from temporary
transaction costs, taxes, regulatory costs, or other differences in their price.
additions to fundamental stock value. Insider Trading: Trading a security on the basis of
Equity Security: An instrument representing and con- confidential or privileged information, to which one
veying ownership interest in a corporation, i.e., stock. has access as an “insider” (e.g., as an officer, director,
Eurobond: A bond sold in a country other than the one or attorney) of the corporation issuing the security.
in whose currency the bond is denominated; for This is illegal in many countries, because it disadvan-
example, a U.S. bond sold overseas. tages other investors.
Eurodollar: A U.S. dollar on deposit in a foreign bank; Instinct: A proprietary electronic securities trading sys-
usually a European bank, possibly a foreign branch of tem, owned by Reuters, that does about 13 million
a U.S. bank. trades per day.
European-Style Option: An option that can be exercised Institutional Investor: An institution with a large
only on its expiration date, rather than before that date. portfolio, such as a mutual fund, a public or private
See “Option” and “American-Style Option.” pension fund, a labor union, or an insurance company;
Foreign Exchange: Foreign currency market; foreign the trading is usually the responsibility of a profes-
currency is bought and sold for immediate or future sional money manager.
delivery. Intermarket Trading System: An electronic network
Forex: The informal market for foreign currency. linking stock exchanges in the United States, allowing
Fourth Market: Securities transactions made directly orders to be routed from one exchange to another
between institutions, without the intermediation of exchange offering a better price.
brokers or dealers. Investment Banker: A firm that underwrites stock,
Futures Contract: An agreement to buy or sell a advises other firms on how to raise capital, arranges
commodity (including financial instruments) for deliv- acquisitions, etc. See “Underwriting.”
 Acronyms and Glossary .103

Liquidity: The characteristic of a market (or of a listed example, one offsets purchase of a futures contract by
security) with enough potential buyers and sellers to selling a futures contract of the same kind. (2) In
allow large transactions without a substantial change international trading, to open a position in one country
in the prevailing price. and close it in another, under an agreement between the
Listed Security (also listed option, listed future): One two exchanges.
that has been accepted for trading by an organized and Open Outcry: The method of trading on commodities
regulated securities exchange. Unlisted securities are (and futures) exchanges, where traders shout out their
traded in the over-the-counter market. buy and sell offers.
Locked-In Trades: Transactions that are matched and Option: A contract conferring the right to buy (call) or to
confirmed by computer, usually at the place of the sell (put) a security at a designated price during a
trade, before being sent to a clearing organization. specified period.
Long Position: Shares (or other instruments) owned by Over-the-Counter: A market where stock transactions
an investor or dealer. take place through dealers, but not on or through an
Maintenance Margin Call: A call for additional funds to exchange or centralized market.
be put into a margin account because of an adverse Passing the Book: Transferring the responsibility for
market movement. portfolio trading from one location to another in a
Margin: In securities markets, the amount that must be different time zone, in order to trade for more hours of
deposited with a broker by one buying securities-the the day-the ultimate is “24 hour trading. ”
broker extends credit for the remainder of the purchase. Pit: The floor of a futures exchange, surrounded by tiered
In the United States, minimum margin requirements platforms on which traders stand to shout their bids and
are set by the Federal Reserve Board of Governors. In offers (see ‘Open Outcry”).
U.S. futures markets, both buyers and sellers put down Position: An investor’s or dealer’s stake in a security or
initial margins, which are defined as performance in a market. A long position equals the number of
bonds or good-faith deposits to assure that the trader shares owned. A short position equals the number of
will fulfil the contract. The minimum margin require- shares owed.
ment is set by the clearing entity of the futures Price-Earnings Ratio: The current market price of a
exchange. If the futures price moves adversely, the stock divided by its earnings per share.
investor will be called on (daily or more often) to put Private Placement: The distribution of securities, not
up more money or collateral. listed on an exchange or organized over-the-counter
Marked-to-Market The daily or intra-daily adjustment market, to a small number of usually institutional
of settlement obligations (in futures and options investors. Such placements are exempt from many
markets) to reflect current market prices. Marking-to- SEC and state registration requirements.
market determines the amount of margin that must be Program Trading: The simultaneous purchase (or sale)
held, and is done by clearing organizations to limit of a large, diversified portfolio of stocks, ordinarily
their risk to one day’s market movement. using a computer to handle the complex order routing.
Market-Maker: A dealer who makes firm bids and offers Prospectus: A description, e.g., of an issue of stock,
at which he will trade. In some markets (e.g., the U.S. giving essential information about the stock for the
over-the-counter market and the International Stock benefit of potential buyers; (in the United States) a
Exchange) there are competing market-makers; in summary of the registration statement filed with the
others (e.g., the New York Stock Exchange) there is SEC.
one designated market-maker for each stock, called a Prudential Regulation: Regulation aimed at assuring the
specialist. fairness of a market, and protecting the investor from
Mutual Fund: A fund operated by an investment fraud, manipulation, or unrecognized risk.
company that raises money from the public (by selling Put: See “Option.”
shares) and invests it in stocks, bonds, options, Rolling Settlement: An arrangement whereby trades can
commodities, or money market securities. be settled on any business day, as opposed to one or
Netting: The determination of the difference between more designated days for each trading period.
one’s total credit and total debt positions, which results Same-Day Funds: Payment is final on the same day it is
in a single amount that a market participant either owes made (checks do not represent same-day funds,
or is owed. because it may take them several days to clear, during
Offset: (1) In futures markets: to close out or cancel a which the receiver of the check does not have access
position by taking an equal, opposite position-for to the money).
104 . Trading Around the Clock: Global Securities Markets and Information Technology

SEAQ International: The automated trading support buy or sell when the market reaches a certain price) for
system used to facilitate translational trades at Lon- other brokers, 3) to buy for or sell from his own
don’s International Stock Exchange. inventory when necessary to provide liquidity and to
Seat: Membership on an exchange. moderate or smooth out price jumps, and 4) through
Secondary Market: The market in which stocks are these and related means to maintain a fair and orderly
traded after their initial issuance and placement. The market.
exchanges and other markets discussed in this report Standards: A criterion established by authority, custom,
are all secondary markets. or general consent as a model or a measure of quality,
Security: An investment contract conveying participation quantity, form, size or some other parameter. In
in a common enterprise, in which there is expectation information technology, for example, general confor-
of profit resulting from the efforts of others; this mance to a standard makes possible interoperability or
includes stocks, bonds, and options, but not futures interconnectivity of systems.
contracts. Third Market: Trading exchange-listed securities over-the
Settlement: Payment to the seller and delivery of stock counter rather than on the exchange.
certificates (or other means of transferring ownership) Treasuries: Bills, bonds, and notes issued by the U.S.
for the buyer. Treasury.
Short Position: The number of shares (or other instru- Underwriting: The act of buying new issues of securities
ments) owed by an investor or dealer; see ‘short sale. from issuing corporations, and reselling them. This is
Short Sale: The sale of a security which is settled by one of the activities of investment bankers, but it is
delivery of borrowed securities (rather than securities usually carried out through the formation of an ad-hoc
owned by the seller). Generally, the seller expects to syndicate.
buy securities later, at a lower price, to cover the short Universal Banking: The most common bank regulatory
sale. arrangement, whereby banks can engage in most
Specialist: An exchange member who acts as designated financial activities, including securities underwriting
market-maker on an exchange for one or more stocks; and trading. In the United States and Japan, in contrast,
the specialist’s functions are: 1) to assist other banks are restricted from engaging in many securities-
members on the floor find buyers or sellers with whom related activities, including underwriting.
to trade, 2) to hold and execute limit orders (orders to
 Index

access deregulation 4, 11,28,47 Federal Reserve System 24,60,69-70

American-Style Option 48 Federation Intemationale des Bourses de Valeurs FIBV 3,
Amsterdam Stock Exchange 61 61
Arbitrage 4,9,37,40-41 finality of payment 66
Article 65 (Japan) 29,43 Financial News Network 14
Associated Press 14 firebreaks 64
Auckland 17 foreign membership in exchanges 11, 14-17, 19,44
AURORA 18,48 foreign portfolio investment 27,31
Automatic Data Processing, Inc. (ADP) 14,15, 16 forex 14-16,55
Frankfort 42
Bank for International Settlement 61,62 fraud, abuse 4,43,49-50,72-73,75
Bankruptcy Code (U.S.) 65 futures 2,4,6,8-9,14,16-18, 21-22,23,33-34,39-41,43,
banks 2, 4-5, 14, 22, 29, 32, 37-38,4043, 48, 57, 62, 47,49,55,57,63-65,69-70, 72,74,76,78-79
64-67,70,73-75,78 futures exchanges:
Big Bang 3,28,4445,4748 Chicago Board of Trade 16-18,33-34
bond dealers 15 Chicago Mercantile Exchange 16-17,33-34
bond markets 23,33,74 LIFFE (London) 18,33
book entry 19,55,58,60 MATIF (Paris) 17,34,49

Canada 14,27,29-30,37,55-56, 66,72,74, ’76 GEMCO 16

capital imbalance 26 Glass-Steagall Act 29,43
capitalization of stock markets 23 global custodians 68,70
CEDEL 61,68 GLOBEX 16-18,43
Chicago Board of Trade 16,33-34,48 Greenspan, Alan 24,64
Chicago Board Options Exchange 18 Group of Thirty 37,59-63,68-69
Chicago Mercantile Exchange 16-17, 33-34, 41, 43 recommendations of 62
Cincinnati Stock Exchange 18 U.S. working committees of 60,63,68-69
Citicorp 16
clearing and settlement 3-4, 8,37,42,55-70,74 harmonization 3-4,21-22,24,47-49,59, 65,67-70
goals of 3,55-56 Hong Kong 12, 17,37,68
interfaces 14
models of 3 ILX Systems 14
Comite Consultatif International Telegraphique et Tele- individual investors 2,25-26,39,42
phon 21 information services vendors 1,5, 13
Commodity Futures Trading Commission (U.S.) 9, 34, information sharing 4,60,63,65-67,70
65,70,76 information technology (computers, telecommunications)
crash of October 19872,6,28, 32 1,6,11,26,32-33,36,37, 39
cross-listing of stocks 29 initial offerings 34
cross-national diversification 11,28-30 Instinct 16
custodian 43, 57,67-68,70 institutional investors 1,5-6,25-28,30-31,34, 37-38,41,
44,46,59,68,72,79
default 4,56-57,65-66 International Futures Exchange 16
Denmark DV 34,61,73 International Organization for Standards 21,76
depositories 42,55-58,62,67,69 International Society of Securities Administrators 3,61
deregulation 3-5,11,28,32,43-44,47, 71-72,76,78 International Telecommunications Union 21
Deutscher Kassenverein 58 International Thomson Organization 14
digital data 13,16 Irish Futures and Options Exchange 18
Dow Jones & Co., Inc. 14-15
Japan (see stock exchanges, clearing organizations) 1-2,
enforcement 5,37,43,53,62,70,74, 76,78 6,12,23,25-34,37-38, 4044,50,55-58,60,72-73,
Eurobonds 29 78
Euroclear 61,68 Japan Securities Clearing Corp. 57
Eurodollar 17
European Community 1-3,5,7,21,37,47,61, 74,76 Knight-Ridder 14-15
–l05-
106 . Trading Around the Clock: Global Securities Markets and Information Technology

large block trades 45 risks 1-5,7-9, 19,21,23-26,28,31,33, 35-36,37,55-59,

London (also see stock exchanges) 3,7-8,14,16-18,26, 61-70,71-73,78
28-30,32-34,43-45,47-48, 55,65,71 rolling settlement 58
London Futures and Options Exchange 18
Salomon Brothers 13,33
margins 15,39,41,56,63-65 same-day funds 4, 60, 65-69
Market News Service 14 scenarios 5-8
Memoranda of Understanding (MOU) 7,76 SEAQ International 30,44-49
Merrill Lynch 32 Securities and Exchange Commission (U.S.) 21,26,30,
Monitor Dealing Service 16 59
mutual funds 2, 26,29, 35,50 Securities Investor Protection Corp. 65
SICOVAM 61
NASD, NASDAQ 3,16,18-19,30,4244,60,63 Singapore 17, 19,33
national debt 27 Singapore International Monetary Exchange (SIMEX)
National Securities Clearing Corp. 57,63 17,33
national treatment 5,53,73-74,77 standards 1-2,5,7-8, 19,21-22,24,28,33,35, 53,59-60,
networks (communications) 1-2,6, 11-12, 15, 36,48, 74
New Zealand Futures and Options Exchange 18 64-65,67-68,70,74-76, 78
Nikkei 23,33-34 stock exchanges:
International Stock Exchange (United Kingdom) 3,29,
obstacles to international trading 1,3-4,8, 13, 19,28-29, 4344,55,61
37,46,60,67 New York Stock Exchange 3,16,18-19,29,33,38,57
options 4, 14, 17-18,23,34,41,43,48-49, 55,57,63-65, Tokyo Stock Exchange (Japan) 2,23,30,32,37,41,43,
67 57,61
Sydney 17, 18
Paris 17 Sydney Futures Exchange 18
Paris bourse 3,34,49
Portal 19 24-hour trading 33,55
portfolio diversification 2,50 technological innovation 6
President’s Working Group on Financial Markets (U. S.) technology 1, 11, 13-16,19,21-22,26,33-34, 36,37,43,
64 4546,49,65,67,70
privatization 26,28,49 Telerate, Inc. 14-16
Tokyo Grain Exchange 18
Quotron 14-16 Tokyo International Financial Futures Exchange 18
Trade Acceptance Reconciliation System (NASD) 18
reciprocity 6,73-74,76 trading systems (automated) 1-2, 11, 14, 16, 18,46,70
regulation 4-6, 8, 19, 21-22, 24, 26, 28-29, 32-33, 37, transaction costs 3-4
4244,47-50,53,60,62, 68,70,71-72,74,76-78 trends driving globalization of markets 25-26
access regulation 4, 72 two-tier market 26,46
prudential regulation 4,28,37,47,50,53,72, 75-76,
78 Uniform Commercial Code 55
regulatory arbitrage 4, 8,75-76, 78 universal banking 43, 73-74
Reuters 13-18,43
risk management 63 Zurich 17,34